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The ESM: To join or not to join

THOUGH the new eurozone bailout instrument, the European Stability Mechanism (ESM), is still a work in progress, one of Slovakia’s ruling parties, Freedom and Solidarity (SaS), has already agreed that its deputies will not back Slovakia’s participation in it. The ESM is supposed to replace the existing European Financial Stability Fund (EFSF) from 2013. On April 26 SaS party boss Richard Sulík even went so far as to call the ESM a fraud committed on European taxpayers.

THOUGH the new eurozone bailout instrument, the European Stability Mechanism (ESM), is still a work in progress, one of Slovakia’s ruling parties, Freedom and Solidarity (SaS), has already agreed that its deputies will not back Slovakia’s participation in it. The ESM is supposed to replace the existing European Financial Stability Fund (EFSF) from 2013. On April 26 SaS party boss Richard Sulík even went so far as to call the ESM a fraud committed on European taxpayers.

Aside from SaS, the four deputies of the Civic Conservative Party (OKS), which sits within the ruling coalition Most-Híd party caucus in parliament, may also refuse to back the mechanism. Faction leader Peter Zajac said they might have “issues” with the ESM as well. Prime Minister Iveta Radičová wants the ESM to clear parliament and says she is ready to hold talks with each political party until the very last moment.

Opposition leader Robert Fico criticised SaS and said that his party, Smer, would not tolerate statements through which political parties might try to pick some “cheap political gains”.

Fico, whose party could play a crucial role in the event that SaS refuses to vote for the ESM in parliament, added that he expects the government to support the ESM unambiguously.

SaS’s partners in the ruling coalition have expressed reservations about the way it has chosen to communicate its stance. SaS has retorted that it is the only parliamentary party that will not succumb to what it calls false solidarity.

“We haven’t forgotten that first and foremost we are here for the people of Slovakia, to represent their interests, not the interests of foreign banks, which for a long time have been earning from high interest rates on loans given to irresponsible countries,” Sulík said on April 20, as quoted by the TASR newswire.

Sulík added that it is a matter of principle for Slovakia and that he is aware that politicians in Brussels “won’t be enthusiastic, but we have to live with that”.

Most-Híd party boss Béla Bugár said that SaS was using the topic simply to differentiate itself from the rest of the ruling coalition at any price.

As for the OKS, Zajac said that he and his colleagues had serious doubts about the ESM but would explain how they intended to vote in a week or two.



The safety net



Eurozone leaders agreed on the rules of the ESM, which should begin operating from July 2013, at meeting in Brussels in March. The bailout mechanism must be ratified by the national parliaments of individual member states. It will be backed by €80 billion in cash, paid in directly by member states, plus €620 billion in capital that can be called on when a lending requirement emerges. Its effective lending capacity will be €500 billion; the extra €200 billion is being raised in order to provide the fund with a premium credit rating. The €80 billion should be collected within three years, with €40 billion available from launch and the rest received by 2016.

Slovakia’s share should amount to 0.824 percent of the total fund, as opposed to the 0.99 percent which is the country’s contribution to the existing EFSF. The reduction came as a result of a compromise proposed by Estonia which allows smaller countries like Slovakia, Slovenia and Estonia itself to contribute around 17 percent less in contributions than they currently do to the EFSF.



Outside politics



“I would not rush in with excessively fast or sensation-seeking conclusions, especially when the subject of discussion concerns not only 5-million-strong Slovakia, but the stability of the 331-million-person eurozone and the credibility of the euro, the second most important global reserve currency,” Volksbank chief analyst Vladimír Vaňo told The Slovak Spectator.

The creation of the EFSF was subject to criticism, as well as bold statements ahead of the general election last summer, but in fact Slovak participation in it was supported in an August 2010 parliamentary vote by 140 out of 142 MPs present, Vaňo noted.

“Participation in the EFSF as well as in its planned continuation, the ESM, are beneficial for Slovakia in raising its credibility in bond markets and hence lowering the cost of servicing its public debt, which has jumped from less than 28 percent of GDP in 2008 to over 45 percent of GDP, as forecast, next year,” Vaňo said.

As for the impact that Slovakia’s refusal might have on the functioning of the eurozone, Vaňo said that aggravation of the turbulence on eurozone debt markets might in the worst case affect the recovery of the real economy.

“Such a scenario might mean a risk of repeated recession, with all its consequences not only for the biggest economies like Germany, but also for their trading partners, like Slovakia,” said Vaňo.

Listing other risks, Vaňo said that a potential loss of credibility for the euro as the second most important reserve currency might curtail the demand of global central banks for the sovereign debt of eurozone member countries and that this would mean a higher cost of borrowing for virtually all eurozone members.

The consequences of Slovakia’s refusal to support the ESM would depend on whether other and larger countries were to follow Slovakia’s lead, or whether the ESM could be constructed without Slovakia, said Juraj Karpiš, an analyst with the Institute of Economic and Social Studies (INESS).

Nevertheless, Karpiš told The Slovak Spectator that “the existence of the ESM will make it possible for countries with irresponsible fiscal policies and influential financial institutions to shift their losses and risks to the taxpayers of other countries, which strengthens the moral hazard in the monetary union and might lead to growing tension between particular member countries or to nationalistic tendencies.”

According to Karpiš, the ESM and its credit sources are siphoning resources away from the private sector, increasing the cost of refinancing and thus decreasing future economic growth.

The ESM can be viewed as the European version of the International Monetary Fund (IMF), i.e. a safety net for extreme situations, Vaňo said.

“It is neither a panacea nor a replacement for necessary fiscal consolidation and healthy long-term fiscal policies,” Vaňo said. “As in the case of the IMF, the use of this safety net is associated with fierce restrictive measures and de facto temporary loss of a major part of national sovereignty with regards to management of public finances.”

The example of Ireland suggests that voters are not happy to see decisions about public finances being taken over by an external multinational creditor, be it the IMF or the ESM, he added.

“A safety net is associated with conditions that don’t make it such an alluring, or palatable option to seek, but rather one to avoid,” Vaňo told The Slovak Spectator.



Alternatives



In terms of an alternative to the ESM, Vaňo said that this amounts to the same as was the case for Hungary in October 2008: international assistance through the IMF.

“The biggest contributor to the IMF is the USA, and such an alternative would hence equal nothing more than a public admission that even 60 years after the Marshall Plan, Europe is not able to stand on its own and resolve its internal crises and turbulences without the external assistance of the world’s biggest economy,” Vaňo concluded.

Karpiš, however, identified another alternative: debt restructuring.

“An adequate solution would be a directed restructuring of the debts of problem countries with the imposition of part of the losses on investors and subsequent support for systematically important financial institutions negatively affected by this step from the public funds of their home countries,” Karpiš said.

Some have expressed concern that Slovakia’s eventual refusal to support the ESM might somehow impact the country’s position in relation to the future EU budget. But Karpiš argued that acceptance or rejection of changes to the Lisbon Treaty, necessary to legitimise the existence of the ESM, should be left up to member countries and shared EU sources should not be used to influence this decision.

“Despite this, it would be still worth Slovakia exiting the ESM even under threat of reduced European transfers,” he said.



Solidarity?



Nevertheless, advocates of the European safety net stress that it is an expression of European solidarity, one of the pillars of the European Union.

Karpiš rejected this interpretation, however: “The ESM is not an expression of solidarity.”

He added that thanks to the safety net it is possible to pass losses that came as a consequence of bad decisions made by commercial financial institutions or politicians onto the shoulders of taxpayers, often in other countries. According to Karpiš, the safety net is taking its toll on socially weaker groups through tax hikes and cuts to subsidies from the social system.



“Considering the state of the public finances of some European countries, which are drawing or in the future will draw assistance from the ESM, there is a real possibility, that they will not be able to pay these obligations and part of these costs, via guarantees, will fall on Slovak taxpayers,” Karpiš told The Slovak Spectator. “Such a scenario, considering the low living standards in Slovakia compared to the countries that have been profiting from the existence of the EFSF and the fact that Slovakia, from its own resources, has carried out a costly restructuring of the banking sector and consolidation of its public finances, is undesirable and indefensible.”



Karpiš added that higher taxes flowing from the need to cover the expenses of eurozone guarantees would decrease Slovakia’s competitiveness and of those firms operating in Slovakia compared to other new member countries, which have not yet introduced the euro and thus also the economic growth and the pace with which Slovakia catches up with the living standard of older member countries.


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