2012 – The Year When the Light at the End of the Tunnel Began to Emerge?

The year 2012 is likely the best of the last four crisis years in the European Union, but given the challenges that await it next year, it still has a long way to go before it can be said that the crisis has been overcome.

Pressed by a financial and debt crisis that threatened the very survival of the common currency, the euro, member countries seriously took on the task of a comprehensive overhaul of the Economic and Monetary Union (EMU), which had functioned well only until the first crisis.

The year coming to a close could in the future be marked as a turning point for breaking the crisis, the year when the light at the end of the tunnel began to emerge. The European Central Bank’s decision to buy bonds from countries with debt problems, the establishment of the European Stability Mechanism (ESM), a permanent fund to assist countries in financial difficulties, which became operational this year, financial assistance to Spanish banks, agreements regarding Greece, and several measures to eliminate deficiencies in the structure of the eurozone have increased confidence in the future of the common currency and reduced the risk of collapse. At the end of the year, a single mechanism for the supervision of banks in the eurozone was agreed upon, the first step in establishing a banking union.

A significant step towards closer EU integration was taken in March with the signing of the Treaty on Stability, Coordination and Governance in Economic and Monetary Policy, known as the fiscal pact, which includes stricter budgetary rules and automatic sanctions for those who violate them. Since there was no consensus to implement this through treaty changes, it was decided to do so by signing an intergovernmental agreement that comes into force when ratified by 12 eurozone member countries. The agreement was signed on March 2 by 25 member countries, all except the United Kingdom and the Czech Republic. So far, it has been ratified by 16 member countries and will come into force on January 1, 2013.

The fiscal pact is intended to be a brake on debt. The signatory countries have committed to maintaining a balanced budgetary policy, halting the growth of debt, and beginning to reduce it. Provisions that the structural budget deficit must not exceed 0.5 percent of GDP, and public debt 60 percent of GDP should be incorporated into their constitutions or into laws that have constitutional force. In the event of a breach of the agreed rules, penalties would follow. Exceptions to the “golden rule” are possible only in extraordinary situations that are beyond the control of the member state and only temporarily, provided that this temporary deviation does not jeopardize medium-term fiscal sustainability.

The Court of Justice of the European Union will be responsible for monitoring compliance with the “golden rule.” The European Commission will report on whether member states have incorporated a ‘debt brake’ into their legislation, and one or more countries will be able to sue another member state that violates the rules. However, the fiscal pact itself does not resolve the current crisis but can help prevent future crises.

By mid-year, interest rates on Italian and Spanish bonds were breaking all records, and there was a real danger of Greece exiting the eurozone. The situation calmed in August when the European Central Bank announced that it would buy bonds from countries under pressure from financial markets in unlimited quantities, provided they adopt and implement reform programs like those countries that requested financial assistance. This lowered borrowing costs, normalized the situation, and yields on 10-year government bonds of Italy, Spain, Portugal, Ireland, and Greece significantly fell.

Under pressure from the crisis, the leaders of member countries tasked European Council President Herman Van Rompuy at the June summit to develop details and concrete guidelines with deadlines for establishing a true economic and monetary union, in which the deficiencies exposed by the crisis would be eliminated.

He did so, but the leaders at the December summit significantly diluted his proposals and left deeper reforms for later. The change in mood towards reforms is primarily attributed to the absence of pressure from financial markets and the fact that German Chancellor Angela Merkel is facing parliamentary elections in September of the following year. Many emphasize that therefore no significant shifts should be expected until after the German parliamentary elections and the elections for the European Parliament, which will take place a few months later in the spring of 2014.

After the agreement on the first pillar of the banking union, the single supervisory mechanism for the supervision of banks in the eurozone, next year the EU will focus on the second pillar, the establishment of a single mechanism for the resolution of banks. The single supervisory mechanism is certainly the easiest part of establishing a banking union; a much more challenging task lies ahead regarding the single mechanism for the resolution of banks and the common deposit guarantee system.
Not everything has yet been resolved regarding the first pillar, the single supervisory mechanism. A decision needs to be made on when direct recapitalization of banks from the ESM will be possible, which would sever the “umbilical cord” between banks and state budgets, which is one of the main causes of the significant growth of public debt in certain member countries.

EU leaders are already facing a tough test in February of the following year when they should agree on the Multiannual Financial Framework for the period 2014-2020. The eurozone still faces a number of potential problems, such as the possibility that Spain may request a bailout program to finance its debts. Beyond the institutional restructuring of the eurozone, the most important question remains – how to stimulate growth, which alone ensures financial stability.