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When Adreas Papandreou said Greece needed the same brave decisions others have taken I presume he was in fact referring to Latvia, Hungary and Romania.

More than the measures themselves, what is interesting about the Brussels acceptance speech were the series of measures put in place to monitor and control Greek economic policy. As the Financial Times put it, the EU puts Athens under close scrutiny.

“The European Commission, the guardian of Europe’s fiscal rules, struck out into uncharted territory by placing Greece’s economic and budgetary policies under closer surveillance than has yet been applied to a eurozone country.”

In fact the European Commission has put Athens on an unprecedentedly short leash, since there is to be a mid-March interim progress report, a further one in mid-May, and quarterly updates thereafter. In addition, an infringement procedure was also launched against Athens for “failing in its duty to report reliable budgetary statistics”.

The Commission recommendations will now be forwarded to EU finance ministers for possible approval on 15-16 February. If endorsed, it will be the first time that a eurozone member country will be put under such strict surveillance.

And the agreed measures are obviously far from being the end of the road, since the EU executive only conditionally approved Greece’s three-year fiscal plan and warned further cuts in public sector wages would be required (that dreaded internal devaluation) if, as many economists believe, the measures so far announced prove to be insufficient to generate the economic growth which will be needed to meet the steep deficit-reduction targets. Thus the die is cast, and Greece will not, as I recommended, be going to the IMF. Such a move is now seen as superflous, since the EU Commission is steadily transforming itself into a local “mini-version” of the Fund in order to try to handle the cases of those countries who show continuing reluctance in implementing those much needed deep structural reforms. I only hope the Commission have the will to follow this through with all the determination that is needed, since if Greece do now finally go to the IMF for help it will surely now be as an ex-member of the Eurogroup.

Not that this weeks session was entirely accident free. Retiring Economy Commissioner Joaquin Almunia gave yet another example of how clumsy he can at times be, by declaring that “En esos países (Greece, Portugal and Spain), observamos una pérdida constante de competitividad desde que son miembros de la zona euro” (a “continuous” loss of competitiveness), which appeared in the English language press as: “Almunia Says South Europe Has ‘Permanent’ Competitiveness Loss“. It isn’t clear to me from this distance whether he was speaking in English and his core message got “lost in translation”, or whether he thought the speech out in Spanish, and the faux pas is down to his advisers. Either way the damage was done, causing even more problems than needed - according to data from CMA datavision, Credit Default Swaps were up on Spanish Sovereign Debt to 151 bps, or up 18.24 on the day. Portugal CDS also rose sharply on the day - 28.47 bps to 195.80.

As Deutsche Bank’s Jim Reid said after the announcement:

Clearly aggressive fiscal tightening can look plausible on paper but the reality is that the path will be full of potential roadblocks. Future strike action will be sign of how prepared the general population is to take the hard medicine. The jury must still be out on this and the market will look to exploit any set backs. However in the short-term the market does seem to have lined up an alternative target.

So the jury still is very much out on just how viable the GDP targets being offered by the Greek government really are. George Papaconstantinou, Greece’s finance minister, may have told the Financial Times that he expected a return to economic growth from the middle of this year - boosted, he said, by strength in the shipping and tourism industries and the “hidden power of consumers” in the shadow economy. But saying this is one thing, and achieving it is another. Growth across Europe will at best be modest this year - let’s say between 0.5% to 1% of GDP at the most optimistic - with labour markets week everywhere, so I think it is rather unrealistic to expect a tourist boom going much beyond the one we saw (or didn’t see) last year, and the same goes for shipping, which is a sector where surplus capacity still abounds. As for those affluent Greek consumers he is talking about, we have to hope they all dig deep into their wallets, and that each and every one of them now insists on a VAT valid invoice!

But so far there is not much sign of this, and retail sales are actually falling steadily (see chart below). In fact I seriously doubt we are going to see much support from internal consumption at this point. Greece is all about exports now, but where are they going to come from? And how is the country going to get a trade surplus big enough to achieve the sort of economic growth they are talking about without a much stronger internal devaluation?

Industrial output has been falling for some time.

And the latest January PMI only served to underline how Greece was becoming detached from the recovery elsewhere.

Commenting on the Greece Manufacturing PMI survey data, Gemma Wallace, economist at Markit said:

“The onset of the new year brought little hope of a near-term recovery in Greek manufacturing. Accelerating contractions in new orders, output and employment caused the headline PMI to sink to an eight-month low. Meanwhile, firms were struggling to cover rising costs, as strong competition and unfavourable demand conditions rendered them unable to raise charges.

Eurozone unemployment hit 10% for the first time in December, underlining the extent to which the timid economic recovery has yet to translate into job creation. Spain’s jobless rate rose to nearly 20%, and Ireland, which like Spain has also been hard hit by a housing downturn, saw its jobless rate climb to 13.3% from 13%. As is normal Eurostat didn’t have data on the jobless rate in Greece, where, as Market Watch point out, statistics are notoriously hard to come by. The lastest - EU comparable - number we have is for October, but at this point such a data point is the next best thing to useless. A similar situation exists in the construction sector, we have no clear idea of what is happening since the Greek statistics office simply to not supply comparable data to Eurostat.

Meanwhile the drama in the bond markets looks set to trundle on:

Greece’s acute problem is the need to raise financing to allow it to roll over maturing debt in April and May, while preserving sufficient cash to fund current expenditure. We estimate an additional funding need of at least €30bn by May. The concentration of maturing debt is unusual, but even if this immediate source of stress can be overcome, the funding profile for coming years remains demanding. The next three months will have a heavy bearing on the profile that is followed, but whatever happens, Greece and other peripheral euro area countries will still suffer from a chronic need to improve productivity, raise national savings and cut government borrowing.
Christel Aranda-Hassel, Director, European Economics, Credit Suisse.

An all the doubt continue as to whether, with the fiscal retrenchment process and the competitiveness correct Greece can manage to achieve the debt to GDP reductions promised in their Stability Programme. As Credit Suisse’s Giovanni Zanni puts it, previously

Nominal GDP growth was systematically higher than the average rate of interest paid on the government’s debt. The implication was that the government could run significant fiscal deficits and still reduce the debt-to- GDP ratio. It did not exploit that advantage significantly, however, and the Greek government’s debt ratio fell only slightly over the period. Things have changed drastically since last year. Nominal growth fell to 0% in 2009. Although it should recover from 2009 lows, we think it will remain subdued relative to the recent past. Even if Greek sovereign credit spreads versus Germany fall back somewhat from the peaks reached last week, it seems extremely unlikely that the favourable dynamics of the past will reappear anytime soon. As such, there are few options open to the government other than to move the primary balance into surplus – a surplus that is sufficient to first stabilise the debt-to-GDP ratio and then push it downwards.

This primary surplus seems a very, very long way off at this point. And Greek bonds fell again yesterday, pushing the premium investors demand to hold 10-year securities instead of German bunds up by 12 basis points to its highest level in a week. The move followed news that Greece’s biggest union had approved a mass strike while tax collectors began a 48-hour walkout. The Greek 10-year yield jumped 8 basis points to 6.76 percent as of 11:45 a.m. in London. The difference in yield, or spread, with benchmark German bunds was at 365 basis points. It widened to 396 basis points on Jan. 28, the most since before the euro’s debut in 1999.

And Citicorp warns that investors may well continue to cut their holdings of Greek bonds amid skepticism the government can overcome public hostility to budget cuts.

“Although Greece has secured the expected backing from the EU for its latest austerity program, we expect markets to remain very fearful of the potential for the fiscal consolidation process to slide or to be derailed by public dissent,” according to Steve Mansell, director of interest-rate strategy at Citigroup in London. Investors, he said, may be “more prone to lighten exposure on any significant spread tightening moves”.

And it isn’t only the bank analysts who are not convinced. According to this article in Le Monde IMF head Dominique Strauss Kahn and his close associate Jean Pisani-Ferry, director of the Brussles based think tank Bruegel also have their doubts:

Celui-ci estime que l’UE n’a ni la vocation, ni les équipes, ni les techniques pour analyser les carences d’un pays et préconiser des remèdes. L’Union n’a pas l’habitude d’affronter l’impopularité des thérapies de choc et pourrait céder aux manifestations de rue. Le FMI peut jouer de sa réputation de dureté pour aider le gouvernement grec à imposer les sacrifices inévitables.

Which in plain English says that they thing the EU Commission has neither the vocation, nor the teams, nor the technical experience to take on a job of this size, and while it is vital that the necessary structures and policy tools are developed, in the meantime the clock is ticking away, and the infection is spreading to the Sovereign Debt of other countries - even as far away as Japan. Basically M. Strauss Kahn seems to feel that the EU Commission is assuming an unnecessarily high risk, and that the Greek dossier should really have been sent to the IMF as a matter of some urgency. I cannot but agree.

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I think we could easily agree that the Hungarian economy and financial policy management by the Government had and have to face a lot of challenges while correcting mistakes made mostly in the past. It seems, however, that the greatest test is to prevent prejudices, perceptions based on false findings, poor information and mistaken conclusions or the consequences thereof. Unfortunately, we find several examples of this kind in Edward Hugh’s article as well. In this context, now we can take occasion to clarify the most characteristic mistakes and misunderstandings in relation to the Hungarian economic and financial policies.

Such is one of the key findings in the article that plays down structural reforms made in the recent period. The author makes ironic remarks that reform measures would lie in the elimination of 13th month pension benefit and restructuring family allowances in total suggesting that it was all to take place as far as changes to the pattern of public expenditure are concerned. Against this background, if we want to list only the last year’s most important measures the following should be mentioned in addition to the elimination of 13th month pension benefit:

- We changed pension indexation with anticyclical effects for the subsequent years;

- We modified the conditions of early retirement with the pension benefits included. Retirement before the statutory age shall involve lower pension benefit;

- Retirement age will gradually increase from 2012 by six months each year until 65 years of age both for men and women;

- We restructured our too generous housing subsidy scheme including the elimination of interest subsidies and social policy aid replaced by a narrower new subsidy scheme;

- Energy price subsidies will be phased out of the social policy system in 2010;

- We changed the method of sick-pay disbursement with a general rate lowered by 10 percentage points;

- Entitlement criteria of family allowance were modified. Now it is available only until the lower limit of age,

- We changed child-care subsidies with shorter periods of eligibility for both child-care allowance and child-care aid;

- Headcount stop entered into force in government agencies from the summer of 2009;

- Nominal wages were frozen for those employed in the public sector;

- To limit spending on curing and preventing healthcare services, hospital financing regulation was created in support of focussed hospital care, i.e. the so-called “performance limit-based accounting system”;

- Scheme of Treasurers was set up from the summer of 2009 to ensure disciplined budgetary management.

These measures will cut pension expenditure in the general government budget by more than 3 per cent of GDP as a result of only the structural moves involving the pension system as shown in the Table below.

In addition, restructuring of housing subsidies, energy price subsidies as well as family and sickness allowances will result in an expenditure cut by 1.0 per cent of GDP in the year of entry into force with increasing order of magnitude in the subsequent years. The Table below indicates well what size of savings we can achieve for more years from the measures relative to the Convergence Programme of Hungary created before 2009. While postponement of investment and development projects could obviously help short-term savings in the crisis period, restructuring of the social system, restraint on public sector wages, sustainable pension expenditure and controlled financing in healthcare should result in long-term, sustainable and structural savings for government budget.

It follows that restructuring moves we took will ensure a declining budget deficit and public debt from 2010. Therefore, the following governments will not need any more to take new austerity measures requiring political sacrifices but to remain on the budget course now established and reap the profit from the results arising in the subsequent years.

Of course, there are reform tasks left on the next government even after the present budget restructuring. The most recent fiscal reorganization involved the composition and balance of government budget. However, six or more month could not be enough to transform institutions and institutional framework. Only formal agreements could be signed for long-term restructuring of companies providing for public transport, which are yet to be fulfilled. Furthermore, more should be done to improve healthcare, education and local governments functioning with the purposes of efficient use of financial resources and raising the level in public services offered, rather than only financing. Thus, after the present fiscal restructuring should be followed by institutional changes during the next election period.

As far as labour market conditions and tendencies are concerned, Edward Hugh has again some wrong findings. It is false that public sector employment grew. Headcount in the public sector went down by 100,000 from 2006. Last year saw only further slowing cut in employment, given the government order (approved in the summer of 2009) of unchanged staffing in force including vacancies.

The new is the start of “Pathway to Work” Program, which is intended for those living on social aid to get back to labour market through communal services projects. In statistical terms, employment in communal services is included in the public sector. To receive a realistic picture, the figures must be adjusted for these effects. Presently, some 100,000 have been involved in the program that opens the way for those concerned to the business sector, rather than to the public one.

This process is reinforced by the shift in tax burden of 3 per cent of GDP. In this context, there is no understanding Edward Hugh’s remark that “… we have seen little in the way of noticeable impact on either employment or on Hungarian exports”. These measures have entered into force only recently (for a few weeks) so it is not reasonable to expect spectacular changes in export statistics applying to the present period yet to be published. That said labour cost cut is the highest in the lower income bracket while it is important for average wage as well. Tax wedge on average wage and marginal tax wedge will go down by 9 per cent and 20 per cent, respectively, relative to the previous year. As a result, changing tax legislation may cause significant improvement in not only labour cost but also in labour efficiency to entail increasingly better international competitiveness and position heading for export markets. As is seen from the figures below, independent analysts’ views underline this improved situation and positions of Hungary.

Based on the most conservative estimates, it is slowly expected that growth outlook in Hungary’s export markets improve putting the country on a more stable and sustainable course of growth than could be hoped on the basis of domestic consumption artificially boosted through further indebtedness both of the public sector already strongly indebted and of the private sector still more strongly indebted.

Revision of 2010 forecasts does not reckon with higher domestic consumption from the former projections. We do not expect, in contrast with Edward Hugh’s allegation, economic growth. In our view, recession of 0.3 per cent could be achieved at export growth of 5.5 per cent. Since Hungary managed to achieve export growth at a higher rate than demand for imports grew in the export markets, the shift in tax burden, lower labour cost and higher labour efficiency, e.g. improving competitiveness suggest that the forecast below is reasonable or even much more careful than many projections given by analysts.

Critics over public debt are in sharp contrast with Edward Hugh’s remarks criticising domestic consumption drop. In particular, the lack of coherence seems on such an economic analysis that would, at one time, require artificial boost on the domestic consumption and a decreasing government debt. Public debt may be lowered below 60 per cent relative to GDP by 2015, due particularly to the fiscal consolidation underway while peaking undoubtedly at around 79 per cent in 2010. However, for the sake of decency, it must be said that 3 per cent of public debt makes only a part of debt in gross since it increases FX reserves from the IMF package.

Also, it should be noted that average public debt relative to GDP in the euro zone will make 84 per cent at the same time. That said there is not much criticism to make over the ruling government moves, especially in relation to public debt since the measures taken in the recent past were as good as only suitable for pushing down the debt level. It is interesting that Edward Hugh’s analysis refers to Eurostat forecasts (autumn of 2009) in relation to fiscal deficit where the European Commission now admitted to have assessed Hungarian fiscal outlook with too much criticism. That is, while they had first found that government deficit would make 4.1 per cent of GDP for 2009, now they see it below 3.9 per cent as originally set out.

Partly with reference to Mark Pittaway, Edward Hugh highlighted external debt as Hungary‘s most pressing problem, somewhat misunderstanding the economic history after the regime change in 1989, and implying that public debt had kept the Hungarian economic growth trapped all the way unlike other countries in the region with better debt figures at the time of regime change. However, this analysis does not consider the economic policy achievements in the second half of the 90s or the fact that public debt has resumed to seem growing since 2001 while private sector indebtedness increased importantly from 2006 on.

If this is really supposed to be the most worrying problem of the domestic business environment, then it should be considered that definitely positive processes were shown on the country’s external debt in the recent months. We saw in 2009 that external financing capacity of Hungary could be positive amid a slightly negative balance of payments as a permanent feature for the coming years since the difference between the balance of payments and financing capacity results from EU capital transfers that may increase further in the years ahead. As a result of these processes, Hungary’s external indebtedness may continuously plunge. Therefore, the package of measures placing emphasis on domestic financial equilibrium and competitiveness in export markets due to which the ratio of imports to exports significantly improved, may offer a solution to external indebtedness as most pressing problem as well.

Also, measures taken in the recent past allowed for Hungary to restore market confidence and do without drawing on IMF loans. It is interesting that Edward Hugh cites separately my statement that “We don’t need IMF money any more and my expectation is that since Hungary is targeting the same track for the future, we won’t need financial help”. This comprises no novelty, however, for those being aware of financing plans of the Hungarian public sector. The country has not drawn down instalments due from the International Monetary Fund since September 2009.

Also, it is well-known that the Government wished to maintain co-operation with the IMF even in this form. What is more, the Parliamentary opposition made statements on similar plans in the recent past. There is no ground for the assumption that the country would deviate from the path of structural reforms, and that the market-based financing would endanger the structural balance of government budget. In this respect, drawing a parallel to Greek political declarations cited does not consider the – not so insignificant - fact that the Hungarian statement was made on the stable market financing after a stabilisation programme and as a result, beside an improving structural balance while Greece, in contrast, did so after a significant deterioration of its fiscal balance.

Based on the foregoing, it could well be a matter of mistake or misunderstanding that this analysis found Hungary’s path similar to Greece’s in terms of economic and budgetary processes of 2009. However, it must be a warning to Hungary since it shows that unchanged preconceptions, perceptions and prejudices could imply the risk of misunderstanding even despite huge fiscal restructuring with the greatest political sacrifices.

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Production increased for the eighth successive month in January, with the rate of expansion hitting a 69-month high. The improvement in the performance of the United States manufacturing sector was most noticeable. The Institute for Supply Management output index rose by 6.5 points since December to reach its highest level since April 2004.

Elsewhere the position was much more uneven, with West European and Japanese manufacturing having a much more qualified start to 2010, with rates of expansion growth well below the global average, - and in the case of some countries well below. Meanwhile emerging economies like Brazil,India and Turkey continued to show a strong performance.

Asia and Emerging Markets

In Japan activity slowed, although at 52.5, the seasonally adjusted Nomura/JMMA Purchasing Managers’ Index pointed to a moderate improvement in operating conditions in the Japanese manufacturing sector at the start of 2010.

Commenting on the Nomura/JMMA Japan Manufacturing PMI data, Minoru Nogimori, Economist of Financial & Economic Research Centre at Nomura, said:

“The Japan Manufacturing PMI fell 1.3 points to 52.5 in January. It remains above the key dividing line of 50.0, but has continued to fluctuate in recent months. Although the PMI has been holding firm, the sharp rebound phase from February through to August in 2009 has lost steam. Furthermore, the New Export Orders Index fell rapidly, by 3.2 points to 51.5, signaling that the yen’s appreciation has depressed exports which are the main factor behind the current recovery in the Japanese economy. Exports are an important factor of the future of the Where an expansion of production was signalled, panellists generally attributed growth to higher intakes of new orders, which increased for the seventh month running in January. However, the latest improvement in firms’ order books was the slowest in that sequence amid concerns over the sustainability of economic growth. Export sales placed at manufacturers rose again in January, extending the current period of expansion to eight months. Nonetheless, the pace of expansion was the slowest since last June. Anecdotal evidence suggested that increased new business from China and other Asian countries continued to support export growth.

January data signalled that backlogs were depleted at the fastest rate since last June, largely as a result of slower new business growth and a robust rise in output.

Elswhere in Asia, both China and India showed strong expansions. At 57.4, up from 56.1 in the previous month, the headline HSBC China Manufacturing PMI rose to a record high at the start of 2010, signalling a continuing improvement in operating conditions in the Chinese manufacturing sector. The index has now risen more than sixteen points since posting a record low in November 2008. Export sales also rose in January, increasing at a near-record rate. This was in sharp contrast to the severe reductions seen at the beginning of 2009.

Commenting on the China Manufacturing PMI survey, Hongbin Qu, Chief Economist for China at HSBC said:

“Industrial activity continues to accelerate, implying stronger GDP growth in 1Q. But rising input and output prices also point to greater inflationary pressure, which will likely prompt more tightening measures in the coming months.”

The Indian manufacturing sector expanded at fastest pace for nearly one-and-a-half years in January. Climbing to 57.6 in January, its highest level for seventeen months, the seasonally adjusted HSBC Markit Purchasing Managers’ Index signalled a considerable improvement in operating conditions faced by Indian manufacturers. The headline index has now signalled expansion of the sector since April 2009, and at increasing rates for the past two survey periods.

Commenting on the India Manufacturing PMI survey, Robert Prior-Wandesforde, Senior Asian Economist at HSBC said:

“Any lingering concern that India’s manufacturing recovery was tailing off should be well and truly put to rest by this strong release. A second consecutive rise in the PMI has taken the series to a new cycle high, consistent with on-going double digit rises in industrial production. The most impressive part of the release was the more than 5 point jump in the new export orders index, which took it to its highest level since October 2007 and indicated that the recovery is by no means dependent on domestic demand alone.

“At the same time, however, price pressures are clearly intensifying. The rate of increase in input prices was the largest since the PMI began nearly 5 years ago, while the survey suggests that companies are more willing to pass on these rises in the form of higher output prices - something which the RBI is unlikely to take too kindly to. Admittedly, the employment index only inched above 50 but it can’t be long before job hiring picks up more aggressively.”

Elsewhere among emerging economies, the Brazil performance stood out, with the sector expanding at a considerable pace as shown by the fact the headline seasonally adjusted Brazil Manufacturing PMI climbed to 57.8 in January, its highest level since data were first available in February 2006.

Commenting on the Brazil Manufacturing PMI survey, Andre Loes, Chief Economist, Brazil at HSBC said:

“The Brazilian manufacturing industry expanded at a survey record pace in January. The Manufacturing PMI reached 57.8, up from December’s 55.8, with all five of its components supporting the strong performance of the composite indicator.

“In our view, the particularly strong growth of output, new orders and input stocks – all of them reached series record peaks – indicate further vigorous expansions in manufacturing going forward. Employment also grew faster, but as a variable that normally lags production, its expansion fell short of the three components mentioned above. Last but not least, charges rose, albeit modestly, for the fourth month in a row.

“All in, January’s Brazil Manufacturing PMI confirms the very favorable dynamics of manufacturing activity. This highlights the concern recently expressed by the BCB, that the quick reduction of idle capacity could result in increased inflation pressures.”

While the South African PMI continued to show an increase in activity. The index surged to its highest level in 21 months in January, indicating that a recovery in manufacturing is gathering pace as consumer spending picks up, according to Kagiso Securities who prepared the report. The seasonally adjusted index increased to 53.6 from 52.5 in December. The PMI has now been above 50, which indicates an expansion in factory production, for three consecutive months.

Western Europe

In Europe, solid expansions in output were recorded in Sweden, France, Germany, the Netherlands and Austria, but these were in marked contrast to the deeper recessions in Spain, Ireland and Greece.

The Eurozone PMI hit a two-year high, with France and Germany leading the recovery, while Spain and Greece fell further behind. The headline final Eurozone Manufacturing PMI – a composite index based on measures of production, orders, employment, inventories and supplier performance – posted 52.4 in January, its highest reading for two years. The index value was above both its earlier flash estimate of 52.0 and the final reading of 51.6 posted in December. The level of the PMI has risen in each month since hitting a record low last February and has now remained above the neutral 50.0 mark for four consecutive months.

Commenting on the PMI data, Markit Senior Economist, Rob Dobson said:

“The January final PMI readings confirm that the Eurozone manufacturing sector has built on its positive end to last year, with growth of output and new orders the fastest since mid-2007 and above the earlier flash estimates. However, the recovery is becoming two-track, with Spain and Greece in particular falling further into recession when growth in most of the other nations, led by France and Germany, is accelerating. Manufacturers are also continuing to focus on reducing headcounts and lowering stocks despite gains in output. This suggests that they retain a cautious outlook, especially while sales are still being supported by price discounting.”

But the West European picture was characterised by two extremes. On the one hand we have France and Sweden, were economic activity is rebounding strongly, and on the other there is Spain and Greece, where the contraction continues, and the outlook seems bleak.

Business conditions in the French manufacturing sector improved for a sixth consecutive month in January. The headline Purchasing Managers’ Index posted 55.4, up from 54.7 in December. The rise in the PMI reflected faster expansions of both output and new orders during the latest survey period, while supplier delivery times lengthened at a sharper rate. Manufacturing production increased for the seventh month running in January. Furthermore, the rate of growth accelerated to the strongest for almost nine-and-a-half years, with over one-third of panellists reporting a rise.

Commenting on the Markit/CDAF France Manufacturing PMI final data, Jack Kennedy, economist at Markit, said:

“The recovery in the French manufacturing sector remained intact at the start of 2010. Output rose at the strongest rate for almost nine-and-a-half years in January, as the rebound from the record contraction seen in early 2009 continued. While domestic demand remained the primary driver of growth, there was also evidence of strengthening export sales, indicating a broad-based expansion. However, staffing levels continued to be cut as manufacturers targeted cost savings and productivity gains at a time when input price inflation reached a sixteen-month high.”

In Sweden, activity simpled roared ahead, and the Silf / Swedbank Sweden Manufacturing Purchasing Managers’ Index stood at a seasonally adjusted 61.7 in January, well above December’s 58.2. The production sub-index surged to 70.2 in January from 59.7 in the previous month. The new orders sub-index climbed to 66.8 from 63.7, with the new export orders sub-index gaining 4.2 points to 62.3. Despite the improvement in new orders and production, employment levels were slashed again. The employment sub-index stood at 49.6, up slightly from 49.5.

In Spain January data pointed to a further deterioration of operating conditions at Spanish manufacturing firms. Both output and new orders fell at faster rates than in the previous month, while employment continued to decrease sharply. Companies offered discounts to clients in an attempt to boost sales, despite input costs rising again during the month.

The seasonally adjusted Markit Purchasing Managers’ Index remained well below the 50.0 no change mark, edging up slightly to 45.3 in January, from 45.2 in December, indicating that business conditions deteriorated for the twenty-sixth successive month. Production contracted for the sixth month running in January, and at a steeper rate than was registered in the previous month. The latest decline reflected a further reduction in new business.

Commenting on the Spanish Manufacturing PMI survey data, Andrew Harker, economist at Markit, said:

“The Spanish manufacturing sector began the new year with output, new orders and employment all continuing to fall. The steepest decline in input buying for seven months highlights the lack of confidence in the sector, with firms reluctant to invest in new stock until sales have been secured. Manufacturers were again forced to cut prices in January as weak demand made it difficult to pass on higher raw material costs to clients.”

Central and Eastern Europe

Turkish manufacturing sector started 2010 on positive footing as output and new orders rose at robust rates. Increased new orders from overseas continued to provide support to expansion of sector, and the growth in employment was sustained. Higher input cost inflation however droves a further rise in output prices. The headline index posted 53.0 in January, indicating a solid improvement of business conditions in the Turkish manufacturing sector. The rate of expansion accelerated since December, and was the strongest in four months.

Commenting on the Turkey Manufacturing PMI survey, Dr. Murat Ulgen, Chief Economist for Turkey at HSBC said:

“The Turkish manufacturing sector has started 2010 with a solid expansion rate, thanks to robust increases in new orders and output. Overall manufacturing activity has also gained traction, breaking the five-month streak of deceleration in the pace of growth since July. Export order growth was also strong, reflective of an improvement in Turkey’s export markets. Manufacturers continued to slash their finished goods inventories in order to partially fulfil rising orders, while backlogs of work were also reduced for the third month. Employment conditions maintained their favourable trend, improving for the eighth consecutive month. On the other hand, the ominous outlook on cost pressures remained intact in January, as input prices continued to rise much faster than output prices, possibly because of soaring raw material prices. This tells us that inflationary pressures are in the pipeline and businesses may pass on rising costs to their end prices when they feel more comfortable about aggregate demand conditions.”

Business conditions in Russia’s manufacturing sector showed tentative signs of recovery at the start of 2010, according to January survey findings from VTB Capital. Output rose for the sixth straight month, and at a faster rate as new orders increased for the first time since last October. Employment continued to fall, but at a much slower rate than the trend pace recorded over late-2008 and 2009. Inflationary pressures strengthened, but remained relatively weak. The headline seasonally adjusted Russian Manufacturing PMI posted above the no-change mark of 50.0 for only the second time in the past eighteen months in January, indicating an overall improvement in operating conditions in the sector. The latest PMI reading reflected stronger positive contributions from the output, new orders and suppliers’ delivery times indices, and less negative effects from the employment and stocks of purchases components. That said, the latest reading of 50.8 signalled only a marginal overall improvement in conditions, and was below the long-run trend of 52.1.

Commenting on the survey, Dmitri Fedotkin, economist at VTB Capital, reported:

“January’s Manufacturing PMI rose to 50.8, the second reading pointing to an expansion across the sector over the past 18 months. The headline number was supported by new orders crossing the no-change 50 level to reach 53.0, while new export orders also rose (50.8). The output index rose to 52.3, pointing to production rising for six straight months and supporting the recent upturn in official statistics. In addition, at 48.2 the employment index improved for the fourth month running with further stabilization expected on the job market. The input price index rose to 61.4 amid higher commodity prices and freight charges while the output price index rose to 54.0 as companies tried to pass rising costs on to customers.”

Hungary’s manufacturing purchasing manager index (PMI) jumped 4.4 percentage points to 53.5 points in January 2010, the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM) reported on Monday. This marks a halt in the contraction of the manufacturing industry that had started in September 2008. Hungary’s manufacturing PMI stood at 53.5 in Jan 10, up by 4.4 ppts from Dec 09. This is the first time since August 2008 when the index is above 50. (The Dec reading was revised upward to 49.1 from 48.5 originally).

HSBC survey data for the Polish manufacturing sector signalled an overall improvement in business conditions in January, in stark contrast to the marked contraction posted one year earlier. The headline HSBC Poland Manufacturing PMI posted 51.0 in January, having been unchanged at a near two-year high of 52.4 in the previous month. Any figure greater than 50.0 represents an overall improvement in business conditions. The PMI remained above its long-run trend of 49.5 in the latest period.

Commenting on the Poland Manufacturing PMI survey, Kubilay Ozturk, economist at HSBC, said:

“The headline PMI remained above break-even in January, but the momentum that prevailed in the last two months of 2009 appears to have lost some steam, with slower expansions in output and new orders. Domestic and external demand continued to improve over the month, albeit at a slower pace, particularly for the former. A decline in the employment index after a long-awaited rise in December confirms the labour market is not out of the woods yet, while the noticeable drop in output prices indicates a benign inflation environment ahead. Overall, the reading is a reminder that a straight-line recovery may not be that likely, although the Polish economy will continue to outperform its regional peers in 2010.”

Czech manufacturing output grew at fastest rate since March 2008 and the latest PMI data compiled by Markit for HSBC showed an overall improvement in business conditions for the third month running in January. Moreover, the rates of growth for both output and new orders accelerated, and were sharper than the averages over eight-and-a-half years of data collection for the survey. Meanwhile, manufacturers shed jobs at a slower pace and continued to cut charges to support sales drives. Supply delays were again registered as firms raised purchasing volumes. The headline HSBC Czech Republic Manufacturing PMI rose to 53.1, signalling a robust overall improvement in business conditions.

Commenting on the Czech Republic Manufacturing PMI survey, Kubilay Ozturk, economist at HSBC said:

“The headline index improved noticeably in the first month of 2010 on the back of a remarkable increase in output and a solid rise in new orders, underlining the uninterrupted improvement in demand. Both external and domestic markets appear to have been on the mend in January, suggesting a wider economic recovery is under way. The latter was also confirmed by a leap in firms’ purchasing volumes over the month. However, subdued increase in EMU manufacturing PMI in January and the downside surprise in a flash estimate for German 2009 growth suggest the impact of fiscal stimuli and car-scrappage schemes in Western Europe may fade earlier than expected, implying recovery may be gradual and bumpy.”

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Spain’s banks have extensive government bond holdings, and as the spread rises the market value of these bonds falls, so - given that another important part of the banks capital base is composed of land and property assets of uncertain value - the prospect of a slide in the value of the bonds they hold leaves Spain’s government with little alternative but to be seen to be taking “serious” measures, whatever the cost. But quite how Spain’s citizens will react to the news that their government’s policy is now being driven by the need to “calm market fears”, and that the country’s leaders are actively considering asking them to retire at 67, still remains to be seen. Yesterday’s warning shot from political rivals and unions alike may leave their mark in the short term, but it is now clear that things have, in fact, changed, and Spain’s politicians (and the bankers who influence them) are now likely to be much more sensitive to market sentiment than they are to public protest.

The Economic Slide Continues

While eurozone manufacturing sector grew at its fastest pace in two years in January, the divergence between laggard Spain and the rest of the big four economies simply widened, according to yesterday’s Global Manufacturing PMI report. Spain was actually (and just one more time) the worst performer among the 26 countries surveyed. Here in Europe the Markit eurozone manufacturing purchasing managers’ index for January rose to 52.4 from 51.6 in December, but while the data showed activity in Germany, France and Italy continued to expand it was a different story in Spain, where the reading did edge up slightly to 45.3, from 45.2 in December in a move that offered little more than token consolation, since the changes is marginal, and simply confirmed that business conditions in manufacturing deteriorated for the twenty-sixth successive month.

“The recovery is becoming two-track, with Spain and Greece in particular falling further into recession when growth in most of the other nations, led by France and Germany, is accelerating,” said Rob Dobson at data provider Markit.

Commenting on the Spanish Manufacturing PMI survey data, Andrew Harker, economist at Markit, said:

“The Spanish manufacturing sector began the new year with output, new orders and employment all continuing to fall. The steepest decline in input buying for seven months highlights the lack of confidence in the sector, with firms reluctant to invest in new stock until sales have been secured. Manufacturers were again forced to cut prices in January as weak demand made it difficult to pass on higher raw material costs to clients.”

Again,Spanish car sales rose 18.1 percent in January comp.ared with the same month of last year, but these sales are destined to fall back sharply in the second half of this year as government subsidies are withdrawn. According to car makers’ association ANFAC the January sales increase followed a rise of 25.1 percent in December and 37.3 percent in November. Year on year car sales fell 17.9 percent in 2009 (over 2008) to 952,772 vehicles.

The Spanish government began offering 2,000 euro subsidies to new car buyers last May, in addition to a 700 million euro subsidy to replace old cars with energy-efficient models, but this kind of spending is simply likely to disappear as the government moves forward with its austerity programme.

As ANFAC noted, “The continuation of government subsidies is having a positive influence on car sales….….in the second half of the year sales will benegative, with falls over 18 percent as a result of the 2 percentage point rise in VAT and an end to government subsidies.”

Unemployment Still Heading Onwards And Upwards

As the PMI report points out, Spanish manufacturers continued to adjust their workforces in response to extensive spare capacity during January, resulting in further substantial job cuts. Employment in manufacting has in fact now declined in each and every month since September 2007.

Not unexpectedly, the number of workers registered as unemployed in Spain increased by 124,890 in the month of December, and is now over the 4 million mark (4.05 million), according to Labour Ministry data out today (Tuesday). Since January last year, the number of registered jobless has risen by 720,692.

According to Maravillas Rojo, head of the Labour Ministry’s employment department, “January is traditionally a bad month for unemployment. Historically it rises in that month even when the economy is growing”. She added that “The rise in joblessness is a very bad figure, but the tendency for the rise to slow, which began about a year ago in March, continues, although we have yet to hit the ceiling”. And the rate of increase is slowing (see chart below), although there is a marked increase in people who are not registering, and the government deficit adjustment plan will surely start to add to the queues again.

In addition to the rising unemployment figure, the number of taxpayers to the Social Security system has also fallen starkly: there are 257,828 less of them (more than doubling the unemployment figure increase). Such a number implies that, apart from the expected people retiring and in retraining courses, there are many entrepreneurs that are shutting down their businesses. Let us recall that on January 2008, even though the fall in unemployment was similar (132,378), the number of taxpayers affiliated to Social Security was only reduced by 84,697.

The psicological threshold of 4 milion people unemployed has now been broken, with a grand total of 4,048,493. Let us recall the Minister Corbacho asserted repeatedly last year he “did not believe” Spain would reach the figure of four milion people unemployed.

Today’s unemployment figures illustrate we are now in the second phase of the current crisis, since we have gone beyomd the first credit-shock part (which induced layoffs mainly in the construction sector) and are into the second, provoked by the sharp reduction in global output, and now continued by an ongoing drop in internal consumption. The evidence for this is the fact that most of the new unemployed belong to the services sector (102,130 (a monthly increase of 4.5%) and the industrial sector (8,873, monthly increase of 1.7%). Construction “only” added 7,036 layoffs (0.9% monthlyincrease).
Jordi Molins, independent Catalan economist.

So 4.05 million is just the number of people who are signing on at the labour offices, on other measures the level of unemployment is even higher. According to Eurostat data (ILO comparable methodology) there are around 4.5 million unemployed already, not counting those who have already left Spain in the search for work elsewhere (the so called “discouraged” workers). According to the latest Eurostat data the seasonally adjusted unemployment rate for European Union member states (EU-27) was 9.6 percent in December 2009, compared with 9.5 percent in November.

Among member states, the lowest unemployment rates were recorded in the Netherlands at four percent and in Austria at 5.4 percent, and the highest rates were seen in Latvia at 22.8 percent and in Spain at 19.5 percent (see chart). Spain thus ended 2009 with the highest jobless rate in the Eurozone, and by a large margin.

Elena Salgado Fails To Convince

According to the FT’s Victor Mallet Elena Salgado was unable to conceal her discomfort last week, when she met the press to announce her austerity plan designed to slash successive budget deficits and restore the country’s credibility on international markets. Ms Salgado “had good reason to be uneasy. The table of figures she presented on Friday showing Spain’s “fiscal consolidation path” through €50bn of savings over four years had some embarrassingly blank spaces for the projected budget deficits in 2010, 2011 and 2012″.

Spain, as Mallet points out, wants to reduce its total public sector deficit from 11.4 per cent of gross domestic product in 2009 to the European Union target of 3 per cent of GDP in 2013, but - as the empty boxes show - is not sure either if it can, or how to do it. Alfredo Pastor, a professor at IESE business school in Madrid and former deputy finance minister, shares the same doubts: Spain will also struggle to reach the EU deficit ceiling by the 2013 deadline, “We would have to have very high and fast growth, higher than what we can expect,” he told Bloomberg in an interview last week.

“It’s a plan that is essential after our most recent deficit figures,” Finance Minister Elena Salgado told journalists at the meeting which followed the government’s weekly cabinet meeting. But the main problem facing the Spanish government now is credibility. Spain announced an annual deficit of 11.4% for 2009 after previously (even two weeks ago) forecasting the deficit would come in at 9.5% of GDP. In fact it is rather surprising that as recently as last September (when the government first presented its budget plans for 2010) the deficit was still being forecast to come in as low as 5.2% of GDP (52 billion euros), while by November the forecast had already risen to 8.5% of GDP (85 billion euros) and now (just two months later) we are told that it was 11.4% (over 110 billion euros). A number of questions automatatically arise, like just what level of control the Spanish government actually has over its deficit, and just how convincing is the government’s plan to make a three year, 50 billion euro reduction in a deficit which has just shot up in four months by more or less exactly the same amount without anyone (officially) forseeing it!

And Elena Salgado’s still incomplete deficit reduction plans critically depend on economic growth forecasts – which rise to about 3 per cent a year in 2012 – that many independent economists regard as totally unrealistic. Even the IMF, with whom Ms Salgado recently took issue, are not convinced by her numbers and forecast a 0.6% (and not a 0.3%) contraction this year. The government now projects a 1.8% gain in GDP in 2011, with growth in 2012 up as high as 2.9%, from a prior 2.7%. Of course, you can pull numbers (like rabbits) out of any hat you like, but that won’t bring you growth, and certainly not nearly 3% growth in 2012.

“We are moderately optimistic for 2010 and 2011,” Elena Salgado said “If you recall, in June, international agencies also forecast the worst, ultimately, convergence has been to our data” she added.

How she has the temerity to say this is really beyond me.

So even after Friday’s announcement serious doubts remained about Spain’s ability to control its budget spending, particularly since a fifth of the proposed adjustment is supposed to come from the autonomous regions and local authorities that account for more than half of spending. The central government, furthermore, specifically ruled out cuts in pensions, unemployment and social security payments, education spending, research and development or foreign aid. Half the deficit reduction is to come from spending cuts, including a near-freeze on hiring for the civil service (only one in every ten who leave is to be replaced). This means central government, which will bear the load of the austerity plan, about 40 billion euros of it, or 5.2% of GDP.

As is well known Spain is currently grappling with the collapse of a decade-long housing boom that has pitched the wider economy into a deep recession, sent tax revenues plummeting and social welfare costs soaring. Furthermore, in the aftermath of the housing bust, even the government doesn’t expect the economy to return to pre-crisis growth rates anytime soon, making it impossible to meet spending commitments taken on during the boom years. Even more worryingly, despite the fact that the pension reform is needed, and the austerity programme to rein-in the deficit essential, Spain has not one measure currently on the table which is able to restore growth and employment in the short term.

And time is running out. As Victor Mallet puts it - the recent austerity announcement does little answer the one question which is now uppermost in the minds of all those investors and economists who are busy worrying themselves about the future of Europe: can Spain control its budgets and once more become competitive within the constraints of the single European currency?

Mr Zapatero insists it can – “We are a serious country and we fulfil our promises,” he said in Davos – but he and Ms Salgado have yet to prove it, and today’s news that the retirement plans may well be substantially modified only serves to reinforce the doubts.

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But move forward from 2009 with the successful Swedish presidency of the EU billed as the last one under old system and … er… Spain has the Presidency for the first half of 2010, PM Jose Luis Zapatero is hosting events just like under the old system and there’s a Spanish presidency website that looks pretty much look the other pre-Lisbon websites (although at the risk of repetition of praise, the Swedes really had a model of concise clarity for their operation which has not been replicated).

So what’s the point?  The point is the the Spain EU calendar for May 2010 showed an EU-USA summit for May 23-25.  Anyone who showed up early has a chance of catching the new format Champions League final played that Saturday in Madrid.   But as the Wall Street Journal explains, there’s just one problem, or rather two problems.  Since the summit should involve the new permanent EU Council President, it should be in Brussels.  And anyway, Barack Obama isn’t coming.  As the Journal describes it –

In recent days, stories in the European press have described a behind-the-scenes tug-of-war between Mr. Van Rompuy and Spanish Prime Minister José Luis Rodríguez Zapatero over summit minutiae such as the seating plan for the dinner with President Obama and first lady Michelle Obama.

But on Monday, Mr. Van Rompuy’s spokesman distanced himself from the entire gathering. The ill-fated May summit “was prepared by the Spanish,” said Dirk De Backer. “The permanent presidency has never been involved.”

It’s not like the Obamas are doing no travel in the 1st half of 2010.  There is a full family trip (apparently carefully timed for US Spring Break) to Indonesia and Australia.  And he managed 2 trips to Copenhagen, with questionable outcomes, last year.  Notwithstanding the claims from White House sources about the desire to focus on domestic issues, instead the issue with the EU summit seems to plain old irritation with the “who’s in charge” question: who is the counterpart, and where it will be?  Reasonable questions for the President’s planners to ask.

All this is a long way from the George Bush approach.  The EU-USA summits were big events on his calendar: here he is in Slovenia for the 1st half of 2008 summit, and here he is having a financial crisis-themed summit with then EU bosses Barroso and Sarkozy in the 2nd half of the year.  And you can look back each year and see the meetings.  One suspects that he and EU Commission President Barroso had a bond going all the way the back to that fateful Azores summit of 2003.

So was it that under the pre-Lisbon system, it was easier to figure out the procedural aspects of the summit, or that Bush cared more than Obama about the relationship with the EU as a stand-alone entity?  Neither question is especially comforting for the new re-tooled EU.

UPDATE: Statement from the Spanish EU Presidency confirming that Obama will not come –

“We have just been informed of this decision”, said the Spanish Minister at a press briefing in Jerusalem, “but we understand that President Obama’s agenda at this time will not permit him to travel to Europe as he was hoping”.

Given the need to concentrate on economic and budgetary issues, it might be just as well.

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On the other hand, statements like the following:

European officials on Friday sought to quell rumors of a pending bailout for Greece, insisting that the financially troubled nation could still manage to avoid a debt crisis on its own. The effort to allay market speculation came as investor confidence in Greek bonds fell this week to levels not seen in a decade, amid concern over the government’s ability to close its gaping budget deficit and maintain financial stability.

Can simply be seen as officials doing the job they are paid to do, that is talk down the market pressure. Obviously, if the spread on Greek bonds could be talked back down, then there would be no need for anyone else to make a loan, but at this point in time, and especially following the ill fated proposal of Finance Minister Papconstantinou to mount a fund raising roadshow including a visit to China, this possibility looks very unlikely. After all, why should the Chinese banks risk their money buying bonds the German taxpayer is unwilling to buy? As Yu Yongding, a former adviser to the Chinese central bank said, it just isn’t interesting to buy a “large chunk” of Greek government debt in order to help rescue the country simply because their securities “are more risky than U.S. Treasuries”. “Let European governments and the European Central Bank rescue Greece”, he said. Over to you Herr Bruederle.

And despite the fact that Joaquin Almunia strenuously denied in Davos that any kind of plan “B” existed, really they would be fools not to have a plan “B”, and the people involved obviously aren’t fools, ergo….

A top European Union official said on Friday there was no risk that Greece would default or leave the euro zone and the country’s finance minister said he was not aware of any bailout talks. “No, Greece will not default. Please. In the euro area, the default does not exist because with a single currency the possibility to get funding in your own currency is much bigger,” Monetary Affairs Commissioner Joaquin Almunia told Bloomberg TV. “There is no bailout problems.”

Asked if its problems could force Greece out of the euro zone, Almunia said: “no chance. Because it is crazy to try to solve the problems the Greek economy has outside the euro zone,” he said. Almunia said euro zone ministers had prepared fiscal recommendations for Greece and other countries, to be discussed at a regular meeting at European Commission level next week, but denied there was any special EU plan to rescue Greece. “It is a normal analytical document that is written every month,” he said. “We have no plan B. Plan A is on the table. It is fiscal adjustment.”

EU Commission “Ups the Ante”

So now lets turn to Plan A, and to that normal analytical document Señor Almunia refers to, which is due to be discussed by the Commission on Wednesday. Fortunately, the Greek web portal Ta Enea have seen the document, and Reuters have provided us with a convenient English language version of what they saw. What the Ta Enea report makes clear, is that the reason Greek Prime Minister Papandreou has not asked the EU for a “bailout loan” is connected to the conditions which would be attached to that loan. According to the reports, the EU Commission plan to go a lot further than simply providing short term funding on the cheap:

The European Union will tell Greece next week to take extra measures by May 15 to shore up its finances and cut a spiralling deficit, Greek newspaper Ta Nea said Saturday, citing a draft of the recommendations. The European Commission’s recommendations, due to be made public on February 3, include cutting nominal wages in the public sector and setting a ceiling for high pensions, Ta Nea said.

Under the headline “Urgent measures to be taken by 15 May 2010,” the EU document will tell Greece to “cut average nominal wages, including in central government, local governments, state agencies and other public institutions.” The EU will also urge Greece to introduce advance tax payments for the self-employed and possibly a tax on luxury goods, according to the document, excerpts of which were printed by Ta Nea. Most other recommendations, as reported in the paper, are already part of the Greek plan.

Reports also mention putting a complete freeze on public sector hiring, and a system of monthly reports to the Commission along the lines of the Latvian programme. What this effectively amounts to is enforcing the implementation of an internal devaluation process along the lines of the ones adopted in Ireland and Latvia, as outlined in the most recent technical report to the commission (see here), in order to restore competitiveness to the economy and make Greek debt sustainable in the long run. It also amounts to an effective surrendering of part of Greece’s national sovereignty to the EU Commission, and this is the part that virtually everyone is doubtless baulking at.

IMF Waiting On the Sidelines

Obviously, the EU Commission is not the only institution who could furbish the bailout loan, the IMF would serve just as well, and Marek Belka, Director of the IMF’s European Office, has already made it very plain they are ready willing and able to help. And only last Friday John Lipsky, the first deputy managing director of the IMF, said the Fund “stands ready” to help Greece with its debt crisis. According to Lipsky’s statement, the fund is in “ongoing contact” with the Greek authorities following a “scoping mission” to assess the possibilities.

“The IMF stands ready to support Greece in any way we can,” Mr Lipsky said. “It is a matter for the Greek authorities to decide, in collaboration with the European Union, but we are here to help if we are wanted.”

In fact, I personally favour the IMF alternative, given the time scale involved, and the likely programme implementation difficulties, and according to Edmund Conway, economics editor of the UK Daily Telegraph, this view is now shared by many “highly respected” economists:

I understand that in many of the conversations Mr Papandreou had [last week in Davos] with very senior, respected economists this week, he was directly advised to go to the IMF, which would be the ‘cleanest solution’….. But an IMF intervention would have potentially to be channelled through European authorities, since Greece is a member of the euro.

But the EU Commission seems to have very strong reservations about going for the IMF route, which is why the “bitter pill” of the EU bailout loan may well need to be swallowed. My fear here is that EU reservations may mean that history sadly repeats itself, the first time in Latvia and then in Greece, as queasiness about taking on board the full implications of what is involved in correcting competitiveness distortions leads to policy-making delays and mistakes of the kind which in Latvia have produced a resession which is far deeper and longer than was actually needed, but which in Greece could easily lead to very serious problems for the entire Eurozone further on down the line.

Yet the door is certainly not closed on an IMF solution, and George Papaconstantinou did meet with IMF Managing Director Dominique Strauss-Kahn on Friday on the sidelines of the WEF in Davos. The possibility of IMF intervention was left open by IMF Managing Director Dominique Strauss-Kahn in an interview with broadcaster France 24 this weekend, although he certainly seemed to suggest that EU support was more likely. “We at the IMF are ready to intervene if asked, but that’s not necessarily required,” Strauss-Kahn said. “The European authorities, both in Brussels and the central bank, are looking at it and I think they’ll handle it properly” ….”solidarity” within the countries sharing the euro could “fix the problem,”, he said without elaborating…. “It’s the first test of this kind for the euro zone,”.

Contagion Danger Concentrating Minds

Perhaps the strongest argument to support the idea of imminent EU support is the level of contagion risk being experienced. Concerns that Athens may not be able to service its debt have put growing pressure on the euro, and even if some would welcome this as an aid to German export competitiveness, the attendent credibility issues hardly make the situation a desireable one. There are also growing worries that the Greek debt crisis could spill over to other weak members of the Eurogroup, such as Spain, Portugal, Ireland and Italy. The German daily Sueddeutsche Zeitung last week quoted an EU draft memorandum as saying the situation in Greece was creating a “big challenge and in the long term risky,” and could force other euro-zone countries to pay higher risk premiums on their bonds. The spread between Portuguese and German 10-year government debt rose to 120.5 basis points on Friday - up from 114.9 the day before, and the spread on equivalent Spanish bonds is hovering round the 100 basis points mark. Basically, as one European leader after another stresses, it is hardly desireable to let Greece’s problems lead other states to have to pay more to finance their borrowing.

Where’s The Moral Hazard?

Finally, there has been considerable discussion about the dangers of moral hazard in the Greek case. If the EU offer a bailout loan, this will encourage other countries to seek something similar, so the argument goes.

“Moral hazard considerations suggest that the ECB will never openly support a bailout, but we doubt that Greece will be left on its own if the situation were to become critical,” UniCredit analysts said. They referred to the danger that a rescue could reinforce ill-considered fiscal practices that have caused serious problems for Greece and others.

But if we look at the realities of the present situation, then it is clear that what is being offered to Greece in return for a possible loan is clearly not enticing, and indeed it may well be that countries would rather not accept the carrot in order to avoid the stick.

But there are other versions of moral hazard at work here. The FT’s Martin Wolf put his finger on one of them:

At the same time, a bail-out by the eurozone as a whole would create a monstrous moral hazard for politicians. It would only be possible if the eurozone subsequently exercised a degree of direct control over the fiscal decisions of member states. It would, in short, be the fastest route to the political union that many initially believed was a necessary condition for success.

Indeed, the very creation of a monetary union in the absence of a political will for unification could be seen as having been the biggest moral hazard risk taken on board, and no matter how many clauses you put in Treaties beforehand, this risk cannot be avoided when push comes to shove.

But there is a third, and more dangerous version of moral hazard in play here, and this arises from the fact that the EU Commission may itself fail to adequately identify and diagnose the roots of the problem, with the result that the correction measures prove to be inadequate, sending Greek debt snowballing off into default. At this point, if the Greek leaders had been simply “following orders”, then a more substantive form of bailout would become inevitable, and Herr Bruederle’s fears that the German taxpayer may end up having to foot part of the bill would be realised. With this in mind, I really suggest that Commission members and Finance Ministers think very carefully about what they are doing before signing and sealing any definitive agreement with Greece. On the other hand, if the nettle is cleanly grasped, and the necessary changes are introduced both in Greece and in the EU’s institutional structure, then maybe the most important and most enduring outcome of the current economic crisis will be a Europe which is more unified and effective than ever it was before.

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