Klaus Regling Talks Bailouts, IMF, Greece and Deflation

27/1/2014

By Matina Stevis

At the margins of the World Economic Forum in Davos, Klaus Regling — the head of the transitional euro-zone bailout fund, the European Financial Stability Facility, and the permanent one, the European Stability Mechanism — spoke to WSJ’s Stephen Fidler, Matina Stevis and Matthew Karnitschnig.

Here is a full transcript of the interview, in which the senior official and International Monetary Fund veteran weighs in on the state of Greece, inflation in the euro area and the relationship between the euro zone and the IMF.

WSJ: What sort of reaction have you had from the IMF and the others on the idea of helping with Greece’s debt load by extending maturities and cutting interest rates? You think it’s gained traction? And is that going to avoid differences with the IMF over the debt issue?

KR: That’s not clear yet, we haven’t had serious discussions. They took note and we’ll discuss it. That will intensify towards the middle of the year, which is the end of the European part of the program. It will depend on the next review –which has been delayed- but eventually there will be a conclusion to the review mission. And then we can assess this together, in May, June or so.

WSJ: Do you think the IMF will stay involved after the end of the Greek program? Up till now Germany has insisted that the IMF be involved in all of the bailouts.

KR: And not only Germany, several countries: the Netherlands, Estonia, Finland. I think as I’ve said before probably some more support is needed [for Greece]. It will be a lot less than the first and second support programs.  It will be a fraction, if at all. We will see, we have seen many surprises. I remember at the autumn of last year most said Ireland must have something after the end of the program that expired in December. We have to see, it always depends on how things develop and that depends partly on government’s policies, partly on the environment beyond the control of the government.

WSJ: The justification back when the IMF got involved was that Europe didn’t have that expertise. What Greece and others are saying is that Europe has developed this expertise since.
KR: It was both the expertise and the money. On the money side, the IMF is already reducing its involvement. In the first Greek program it was one-third, in the second it was one-tenth. On the expertise, you are right, things have been developing more. But nobody is considering for a current program country to change the setup. This may be very different one day in the future but not in the current situation.

WSJ: How worried are you with the delays in the Greek review?

KR: The next review has to be concluded eventually because without it no money will flow and there will be problems. I know that it has been delayed a few times but there’s an expectation that there will be a mission very soon and I hope that it comes to a conclusion. There have been hiccups in the past, more in Greece than in other countries.

WSJ: With regards to the debt situation, how do you feel about the current inflationary environment and debt? Especially in a country like Greece that faces deep deflation.

KR: I don’t see deep deflation in Greece – until last year we had inflation. Which is actually undesirable, it was a problem that it took so long before the reduction in costs translates into falling prices, which we wanted because we needed to improve competitiveness. It actually happened later than I would have liked to see because we need falling prices. In Cyprus, for instance, which is a much more flexible economy, this happened much more rapidly with a translation of a reduction in costs to lower prices. Which is good, it has to happen. We live in the industrialized world in a period of low inflation. It’s not only in Europe, it’s also the US – not to speak about Japan. The risk of deflation is relatively low.

WSJ: How long do you think realistically, politically speaking, given that this process of internal devaluation in Greece is very difficult, and there are political consequences for that. How much time do you think Europe has before these tensions have serious political consequences?

KR: It’s not easy for the population, that’s true and Greece is the most difficult case. I don’t think they need additional income cuts and I think the course of internal devaluation has run its course because basically the excess in unit labor costs increases or the excess of wage increases above productivity gains that we saw through 2008 has been corrected so there’s not much else to be done on that front. Also, fiscal consolidation is almost done.  The commission forecasts a deficit of 2% of GDP this year and 1% next year. This is better than the Netherlands or Finland. So they’ve come a long way. There’s not much to do on the fiscal side in addition to what they’ve done, no more income cuts. What they still need to do are the structural reforms and that takes times and can also be unpleasant but I think it gets not as difficult for the vast majority of the population as what we’ve seen the last few years.

WSJ: Do you think the worst is behind for the Greeks?

KR: The worst of the adjustment burden is. Of course when you talk to the average people in Greece they don’t see it that way. But us as economists, we look at the data and see that most of the adjustment has happened, and results are beginning to show up. People don’t see it but that doesn’t make the other assessment wrong. But they must continue on the structural side.

WSJ: Looking back, do you see the results of the austerity for the past couple of years as vindicating the idea that the only way to repair the euro zone was this harsh austerity?
KR: It was one important element, yes. It’s not only that. Structural reforms are needed and every country has its own problems. Spain and Ireland had more banking problems, Greece didn’t have a banking problem nor Portugal. Greece had mainly the fiscal problem –it depends on which country you look at. But Greece was the most extreme example. They had deficit of 15.6% five years ago. When it’s that big, it doesn’t matter how big the fiscal multipliers are. Something has to happen, quickly. And otherwise we have been quite flexible in Europe, postponing targets on Spain, Ireland as the economy developed worse than expected so countries had more time to reach their nominal fiscal target.

WSJ: What do you see as the likely outcome in Portugal? If there is a precautionary program, does that involve you waiting and seeing, or would you have to do something more specific? It would be the first time the instrument is used.

KR: We have the instrument but in order to grant a precautionary program to a country we have very similar political processes that we have to move through. This means a unanimous decision by the Eurogroup. For six countries this also means a decision by their parliaments. That’s the same as a full program. There has to be a [Memorandum of Understanding] with the country. Does Portugal need it? I don’t know today. I already referred to Ireland. In September last year everybody thought it would, at least the majority of commentators.

WSJ: Some people still think they do, because of the stress tests coming up.

KR: I’m not worried about this. In the five countries that have borrowed from us, including Ireland, we know their banking system quite well because in each program money has gone to the banks. In Spain all the money went to the banks. In Greece €50 billion went via the government to the banks. We have seen stress tests of these five countries several times with the help of private-sector experts, PIMCO in Ireland, Blackrock in Greece. That’s why the ECB has always said that they would be very surprised if there were big surprises. There may be small surprises, but big ones, I don’t think so. Ireland also has a big cash buffer, they’re so successful in the market.

WSJ: But at the time the IMF was pushing for Ireland to take a precautionary credit line.

KR: That was the majority view at the time. And that’s why I’m using the example. Reality proved to be much easier for Ireland than what people expected three months before. And that’s why I say, honestly, I don’ t know what will happen. If they [Portugal] need the instrument, we are there and we will talk about it. But I don’t know yet. We’ll see around the summer.

WSJ: The conditionality around a precautionary program, is it lighter?

KR: Yes it’s lighter, it’s tailored after the IMF’s like many things we’re doing. There is conditionality, yes, to make it available. But in a way it is light because all EU countries have recommendations from the commission and the council. Every country, including Germany. There’s no real conditionality in that sense, because we know what each country should do. That would be put into an MoU.

WSJ: The reason the IMF wanted it is because it gave it added security vis-à-vis Ireland. I’m wondering the degree to which there is a political element here. One of the things I heard at the time is that Germany in particularly didn’t want Ireland to take the precautionary credit line and that was directly told by Germany, because Germany was eager to present the success of a country.

KR: It’s not only Germany, we all wanted a success and of course there were talks before. But I think in hindsight it’s very easy to see that they didn’t need it. They are down to 3.3% interest rates on 10-year government bonds. So, markets validated the decision.

WSJ: Can we talk about the Single Resolution Mechanism and the ESM’s possible role as backup to the resolution funds as they grow over time but may not be sufficient in the early years. What does that mean for the ESM?

KR: We play several roles in the move towards banking union, to put this in a broader context. We can always do what we have been doing so far, support a banking system like we did in Spain. We are developing a new instrument for direct bank recapitalization, I have the mandate from the Eurogroup to do that. It’s not legally in place yet but there’s an agreement in principle to do it and I’m preparing the set-up for that. So far there’s no direct role for the SRM and SRF but this is still under discussion at the European Parliament so there’s no final agreement on that. We’ll see what happens. The council has agreed on a system where the ESM is not needed. The Parliament has somewhat different views. We have enough to do already, we don’t need that and I’m not looking for new work and new ways to spend money.

WSJ: Are you at all worried about complacency? It comes up in a lot of discussions, especially in that there is a slowdown in reforms.

KR: I think one has to be a bit more nuanced. In the countries that borrow from us there are lots of structural reforms and these were the difficult countries not long ago. According to OECD statistics these five countries are doing more reforms than any other country.

WSJ: I was referring more to Italy and France, for example.

KR: They are not my “clients” and I’m happy about that. In a general sense you’re right, when things get easier there’s always complacency. I think that’s part of human nature, it happens everywhere. But in the EU we have these five countries that are really reforming because there is conditionality, and conditionality works. But the EU as a whole, the way we have set it up, it’s not perfect but there’s a good system of reminding everybody that countries still have to do their homework and we’ve tightened these surveillance systems for every country, also Germany gets them. So risk of complacency is everywhere when things improve but we do try to overcome that.

WSJ: About the idea of a special-purpose vehicle and leveraging the ESM –is that still alive? It wasn’t needed in the event but is this an instrument you think potentially for the future is live or is it in abeyance as it were?

KR:  It’s in abeyance because it’s not needed at the moment at all. For the five countries that borrow from us –and I don’t see another country needing support – we have disbursed €225 billion over the past three years. There’s a commitment for €240 billion so we still need €15 billion. If there is another program for Greece it will be a fraction of the old program, so there will be no need to use additional instruments. We created these leveraging instruments and they are legally in place, they are registered at the Luxembourg exchange, but I don’t see the need at all at the moment. But it’s always good to have instruments available. I’m convinced this crisis is coming to an end but I also know there will be another crisis one day –not very soon but maybe 20 years from now. It’s part of our economic system, and it’s good then to have instruments and not to sit through the nights in Brussels.

WSJ: Is the issue with the ratings of your shareholders a big topic?

KR: There is a very direct impact on the EFSF and when France was downgraded the EFSF was downgraded because the EFSF works with guarantees from the member states and we cannot delink from that. But it’s much less direct with the ESM because the ESM has its own capital. Ratings are less important now than they were a few years ago. We saw that when the US was downgraded, there was no reaction on US interest rates so it’s not that dramatic. I think many of us would consider AA+ to be good enough. That’s a structural shift in bond markets.

Πηγή