–Adds Comments To Journalists In Final Paragraphs
BERLIN (MNI) – ECB Executive Board member Lorenzo Bini Smaghi on
Tuesday once again criticized plans for private sector involvement in
the case of default of a Eurozone member state.
In remarks prepared for delivery at a conference in Florence, the
central banker noted that there exist plans for making more explicit the
conditions under which countries, like companies, would not repay their
obligations and would restructure their debts or even default.
The proponents of these plans argue that such explicit rules would
improve the ability of markets to price sovereign risk and, thus, to
exert discipline on governments with a view to achieving sounder fiscal
policies, Bini Smaghi explained. This view is predicated on the general
principle that investors should bear the consequences of their
decisions, he remarked.
“Although at first sight this may seem reasonable and fair, it is
wrong not only in theory but also in practice,” the Executive Board
member reckoned.
Over 50 years of IMF experience have proven that market assessments
of the solvency of countries tend to be wrong, Bini Smaghi argued.
“In the vast majority of cases, sovereign risk is overestimated or
underestimated over a long period,” he asserted. “This is because
sovereign risk does not depend only on debt sustainability, but also on
the political will to implement adjustment programmes, including
privatisations and structural reforms,” he said.
Moreover, at times markets have “perverse incentives,” the central
banker reasoned. “In particular, large investors who have bought
insurance against sovereign default, often without holding the
underlying asset, stand to benefit greatly from the default and lobby in
favour of it.”
These investors tend to encourage “naive governments” to believe
that debt restructuring can be done in an orderly way, distracting them
from implementing the appropriate policy adjustment, he said.
Bini Smaghi warned that default or debt restructuring is “a
dramatic economic and social event for the country which experiences it
– I would call it political ‘suicide’ – which leads many into poverty,
as experience has shown.”
“It is thus rather peculiar for policy-makers to design policies
mainly with the aim of punishing (or rewarding) certain categories of
investors, rather than considering the ultimate consequences for the
people,” Bini Smaghi said.
The Executive Board member argued that the alternative for
policy-makers is to take responsibility and strengthen the economic
governance framework of the Eurozone.
“First, the governance framework underlying budgetary policy
requires bold changes, with greater automaticity and stronger commitment
on the part of policy-makers to ensure full compliance with the
Stability and Growth Pact,” he said.
Further progress should also be achieved in the implementation of
the single market, strengthening the economic leg of EMU, he said.
Finally, regulatory and supervisory institutions for the financial
sector at the European level need to be further integrated, either by
reinforcing efforts to harmonise practices across the EU member states,
or by further strengthening European authorities, he argued.
“A great deal has been achieved over the past few months, but much
remains to be done to put the Union in a position to meet the challenges
which have emerged as a result of the crisis,” Bini Smaghi said.
Speaking to reporters after his speech, the central banker stressed
again that it is “not in the interest of any country to leave the euro,”
since it would create a “dramatic situation”.
Bini Smaghi argued that markets underestimate the determination of
Eurozone leaders to overcome the challenges their economies face.
For now, the strategy for Greece must be to update its
consolidation program, focusing on measures that may have been delayed
in recent months, he said.
While the time comes for Athens to begin issuing debt again, “we
will see” if the markets have regained confidence, he said. Otherwise,
the Eurozone must continue to assist Greece in implementing its program
of reforms.
–Berlin bureau: +49-30-22 62 05 80; email: twidder@marketnews.com
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