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European Commission

Olli REHN

Vice-President of the European Commission and member of the Commission responsible for Economic and Monetary Affairs and the Euro

Rebalancing Europe

Goldman Sachs 16th Annual European Financial Services Conference

Brussels, 15 June 2012

Ladies and Gentlemen,

Let me first thank you for the invitation to speak to such a distinguished audience. I am pretty sure that we all have the same critical question in mind: How can Europe overcome the intertwined sovereign debt and banking crisis – and how can we return to sustained growth and job creation? I would like to sketch out to you where we stand today both in the immediate fire-fighting and in the medium-term rebuilding of the euro architecture. One building block of the envisaged EMU 2.0 is a financial union, which has a very direct relevance to the banking sector. I will return to this subject towards the end of my intervention.

We are now at a defining moment for European integration. Europe is undergoing a difficult adjustment. This applies to both external and internal economic imbalances. This is reflected in the economic situation. For the EU on average, the economic contraction seems mild for now, but the average cannot hide the fact that growth is very uneven across Member States and survey indicators point clearly to downside risks in the short-term. The on-going turbulence in financial markets, especially sovereign bond markets, is threatening the European economy.

Like GDP growth, unemployment rates have diverged across Member States: in some member states, labour markets have been recovering towards virtually full employment, while others are suffering from unacceptably high unemployment.

As regards public finances, the situation is slowly improving. In 2009 and 2010, fiscal deficits in the European Union were in the order of 6%. By 2011 they had been reduced to around 4%. This year they are expected to be somewhat above 3%, a further welcome improvement.

The stability and convergence programmes of the EU Member States confirm their commitment to stay the course on consolidation. This will mean that on average, fiscal deficits in the European Union will be below 3% in 2013. If confirmed by the concrete budgets for 2013, this should go a long way towards easing market pressures.

We expect the ratio of government debt to GDP to continue to increase this year and reach 93% next year. The stability programmes of euro area Member States are somewhat more ambitious and foresee a level of about 90% in 2013 and a decline thereafter.

This confirms that consistent fiscal consolidation remains a valid priority. Of course, the necessary consolidation should be brought about in as growth-friendly a manner as possible. It is therefore worth recalling that the reinforced Stability and Growth Pact is not stupid, but instead focuses on the structural sustainability of public finances over medium term, thus allowing for differentiation across Member States according to their fiscal space and macro-economic conditions.

This is reflected in the on-going excessive deficit procedures and the country-specific recommendations under the European Semester. The Semester, which is already in its second cycle this year, is a key tool of economic policy coordination across the EU, ranging from fiscal policy to structural policy, labour markets, product markets, and network industries. The Commission adopted recommendations on 30 May, which will be discussed by Ministers next week in the Eurogroup-Ecofin.

On macro-economic imbalances, Europe is undergoing a difficult, but necessary, adjustment. This applies to both external and internal economic imbalances. The build-up of large current account divergences since 2000 was not sustainable: this we have learned the hard way. They have been gradually narrowing, and the re-balancing is proceeding.

However, countries that have been running current account deficits for a long time still need to achieve surpluses to bring their external debt onto a declining trajectory. This requires further improvements in competitiveness. It must go hand in hand with private sector deleveraging and the consolidation of public finances.

Based on the in-depth reviews by the Commission, we concluded that Spain and Cyprus are facing very serious imbalances, not least in their financial sectors, which need to be addressed as a matter of urgency.

Last Saturday, the Eurogroup agreed to establish a credit line for Spain for the restructuring and recapitalisation of the country's banking sector. With a safety margin, up to 100 billion euro is reserved for this purpose, to be specified more precisely after two independent evaluations.

The Commission concluded that in Hungary, serious imbalances have developed, especially the large negative net international investment position. In Slovenia, there are serious imbalances in relation to corporate deleveraging, banking stability and external competitiveness. France has serious imbalances due to large losses in competitiveness and export performance, owing to both cost and non-cost factors.

Italy faces serious imbalances as it has been losing external competitiveness for a decade. All the measures taken so far by the Italian government to address this problem need to be implemented rigorously and in full. Moreover, the proposed labour market reform needs to be adopted by the Parliament as a matter of urgency, and the policy-makers need to ensure that its objective and level of ambition remains commensurate to the challenge of the Italian labour market.

Surplus countries are also adjusting and I would like to draw your attention to some very important recommendations which are part of the package regarding these countries. We have a recommendation specifically for the euro area where we point out that an orderly unwinding of intra-euro area macroeconomic imbalances is crucial for sustainable growth and stability in the euro area. We also state that surplus countries can contribute to rebalancing by removing unnecessary regulatory and other constraints on domestic demand, non-tradable activities and investment opportunities. This is also reflected in individual country-specific recommendations for the euro area Member States.

For instance, our recommendations for Germany include three key elements that will be important for rebalancing.

First, we endorse wage increases in line with productivity, which will help domestic demand. Second, we support the use of fiscal space for increased growth-enhancing spending on education and research. And third, we call for increasing the participation of women in the labour force through phasing out of fiscal disincentives and increasing the availability of full time childcare and all-day schools.

Once Member States follow our recommendations on structural reforms, they will make an important contribution to enhancing the growth outlook for the EU and facilitating job creation. Broad and bold structural reforms can also have a positive confidence effect in the short term.

At EU level, targeted investment in growth can be achieved through a more focused use of EU structural funds. And an increase in the EIB's capital would enhance its lending capacity and thereby provide financing to the real economy, to enterprises and households.

The EIB and the EU budget can be used more effectively through risk-sharing with private investors – thus public investment can leverage private investment. This is the idea behind the project bonds, which the Commission proposed last year. I am glad that the co-legislators have acted quickly to enable the EIB soon to roll out pilot projects – and I have noticed the positive responses from financial markets.

Furthermore, the Commission proposal for the multi-annual budget for 2014-2020 is an instrument for growth and investment in the EU. Almost €500 billion of the budget would go to fund research, trans-European networks, investment in human capital and cohesion policy, again with a better use of private funding sources for EU policies.

Ladies and Gentlemen,

The build-up of debts, deficits and imbalances in our economies did not happen overnight, but over many years. And the readjustment we are now going through won't be concluded overnight either. That is why it is so important to stay the course and pursue sustainable public finances and implement the necessary structural reforms.

Much has been done. Vulnerable member states have stepped up fiscal consolidation and structural reforms. We have built financial firewalls with robust firepower. In addition, the European Central Bank has played an important role to ensure not only monetary but also financial stability.

We have reformed economic governance in a way that anchors a stability culture in the EMU and enables sustainable growth. We have strengthened EU financial regulation and supervision. The banking sector is being recapitalised, and in many countries, restructured.

These actions have contained the crisis – but not tamed it, not to speak of overcoming it. Yet, the counterfactual scenario, that of defaults and disintegration, would have led to a terrible depression. Still, it is evident that our actions have been insufficient with the view of the challenges and the length of the rebalancing process across Europe.

Thus we need to think beyond these acts and deeds, and we need to show what lies at the end of this difficult journey. In other words, we need to map out the direction and steps towards a full economic union to complete our monetary union, including through a financial union. Demonstrating the political commitment of Member States to the euro will be a key part of restoring confidence in the euro area.

Under the direction of Michel Barnier, the landscape of financial services has profoundly changed. The Commission’s proposals have brought more market players under supervision, raised the stringency of regulation, created European supervisory agencies, and, last week, filled in a major missing piece, the proposal for bank resolution.

The next speakers, Mario Nava, acting director in DG MARKT, and Andrea Enria, Chairman of EBA, will surely get into more detail.

In my view, the main building blocks towards a financial union should include such common elements as a single rulebook on capital requirements, integrated financial supervision, a common resolution authority and a single deposit insurance scheme. All these common and integrated elements should be put together into the same overall framework, intended for the 27 Member States, while allowing deeper integration and stronger requirements for the euro area as necessary.

The basic principle is clear: the sharing of risk in the guarantee scheme calls for an integrated, strong supervision of the banking sector. There can be no further mutualisation of economic risk without deeper integration of decision-making. To move further in mutualisation, it is necessary to strengthen our stability culture. This basic balance should guide the prospective construction of both financial and fiscal union.

This same basic principle applies also to the proposal of a Debt Redemption Pact by the German Council of Economic Advisers. It would balance the suggested mutualisation of debt with very strict fiscal rules for the participating member states for a large number of years.

In the financial circles, few doubt that it makes economic sense to create a deep, liquid and stable market for government bonds with the joint issuance of public debt. But this process has provide an answer to the concerns about moral hazard, or a possible free-riding on the budgetary prudence and economic strength of others. To make it rational for all to agree to further risk sharing, further reinforced economic governance must ensure fiscal prudence and minimise moral hazard, which will require a fundamental debate about the pooling of fiscal sovereignty.

All in all, the rebuilding of the EMU will require a profound and wide-ranging process that also has to take into account the relevant legal issues, if responsibilities are to be reallocated and shared. And it must also include a genuine political process to give democratic legitimacy and accountability to further moves in economic integration.

We must respond to citizens in countries which undergo protracted structural adjustment and where unemployment is high. But we must also dispel the concerns of those citizens, who would otherwise perceive this process only as financing a supposedly perpetual flow of transfers.

I know that financial markets move fast. But we lose the process of European integration, if we lose our citizens. That we cannot afford.

Once this is kept in mind, an early confirmation of the steps to rebuild the EMU will underscore the stability and solidity of the euro, and help, even in the short term, to restore confidence – of markets and citizens alike.

Thank you very much.


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