As leaders of the world's largest advanced and emerging economies gather in the Mexican resort of Los Cabos, the mood is decidedly grim. Although the latest Greek election result has offered a temporary respite, G20 leaders know that, with Spanish and Italian borrowing costs pushing higher, the European crisis has entered a dangerous new phase.
"This meeting is coming at an absolutely critical time and we’re waiting for Europe to tell us what it is going to do," said outgoing World Bank chief Robert Zoellick in a panel discussion at Los Cabos. "The danger we’re creating is that the pattern of policy making is increasing uncertainty and making markets more nervous."
Zoellick also criticised European leaders for taking "incremental" steps which unsettled financial markets. The recent €100 billion ($US126 billion) bailout of the Spanish banks, he said, was an instance when they "took a very big bullet and wasted it".
In an in-depth interview with the German publication der Spiegel, Zoellick argued that the solution for the crisis lay in providing additional financial support for those countries that undertake major structural reforms.
So far, he complained, European leaders "seem a day too late and a euro short" in their response to the crisis. He also worried that they were not prepared for the actions they would have to take if the crisis hits full intensity. "If contagion strikes", he said, "eurozone leaders need to be prepared – psychologically and through the European Stability Mechanism – to recapitalise banks. Governments would have to guarantee bank deposits. They have to urge banks to make loans to business borrowers. It is far from clear that eurozone leaders have steeled themselves for these steps if a crisis hits with full force."
Zoellick expressed sympathy for the position of Germany, where more than half the population now considers the euro to be a negative. "Frankly, if I were a German citizen, I would be very frustrated about other people that had not taken steps to reform their economies."
However, he argued that although Germany needed to continue to push for fiscal and structural reforms, it had to be clear that it would offer financial assistance to countries such as Spain and Italy that are pushing through tough reforms that take time to deliver results. "So you need to balance these medium-term reforms with a medium-term assurance of finance", he said.
Zoellick also highlighted that France will play a crucial role in determining how the eurozone debt crisis will play out, saying that French President Franois Hollande "is now walking a very fine line".
Hollande, he said, "could be influential with Germany in coming up with a combination of actions that create the incentives and encouragement for the fundamental reforms that Germany seeks, but also assures economic support for the reformers".
Alternatively, he said, "if President Hollande pursues economic policies that frighten businesses and investors, he will add France to the problem".
In elections on the weekend, Hollande’s Socialist party won a resounding majority in the National Assembly, France's lower house of parliament. Because a Socialist-led coalition already controls the senate, the upper house, Hollande can now rely on the strong backing of parliament.
But France faces major economic challenges, with a heavy debt load and unemployment rate of 10 per cent. Hollande has pledged to cut France’s budget deficit to 3 per cent of GDP next year, from the expected gap of 4.5 per cent this year, but in order to find the €20 billion of annual savings he needs, he’ll have to ditch some of his costly promises – such as hiring 12,000 public servants a year – and instead introduce unpopular spending cuts and tax hikes.
A crisis in need of some French finesse
At a grim gathering of the G20 in Mexico, Europe's leaders are being told to be more bold and also to ready themselves for some shocks – not least, France's Francois Hollande.
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