Next Week's Other Deadline

The market appears to be taking in stride the latest setback in negotiations over Greece.   The euro has recouped all the ground lost in thin markets late yesterday when the Eurogroup discussions broke down.  Each side has their inviolable principles, and yet some compromise has to be found.  It might not be possible to do so on the finance minister level, but may require another heads of state gathering to break the logjam. 

We also note that Greece has been an important catalyst for much of the institutional evolution within Europe since 2010.  The framework developed so that Greece can keep its official creditors whole, such as the EFSF and ESM, was rolled out to other countries subsequently.  In a similar vein, what is being negotiated now is not only about Greece, but about other anti-austerity parties that may come to power later this year in Spain and Portugal.  

Greece has failed to expose a fissure within the European finance ministers.  France and Italy appear somewhat more sympathetic but have not broke ranks.  The EC's Juncker and Moscovici reportedly proposed an alternative yesterday that had Greek support met a Eurogroup rejection.  

France and Italy face their own month-end deadline.  The EC has given both countries (and Belgium) until the end of February to demonstrate the undertaking of substantial reforms to allow it to overshot this year's budget deficit target.

The EC's new GDP forecasts now show Italy's budget deficit coming in below 3% of GDP.   Italy's central bank also raised its growth forecast this year to 0.5% and 1.5% in 2016.  This would appear to remove some pressure off of it.  Nevertheless, Prime Minister Renzi is pushing ahead with reforms.  Over the weekend, the Chamber of Deputies approached constitutional reforms that would it easier for Renzi to push through his reform agenda as it prevents the Senate from blocking legislation.  A final vote is likely next month.  

Separately,  Italy is reportedly considering fiscal incentives and legal reforms to address the non-performing loan problem saddling Italian banks.  The idea is to make it easier for banks to write off the non-performing loans and for lenders to recoup  credit.  The bad loans are estimated at 180 bln euros, or 17% of total loans, a three-fold increase 2007 (~5%).  

There are bureaucratic and regulatory impediments that deter addressing the bad loan situation, though last week a foreign investment firm agreed to buy a 2.4 bln euro portfolio of non-performing loans from Italy's largest bank.  Part of the problem is governance, which coupled with the bad loan problem was the key to the Italian central bank taking control of Banco Popolare Eturia last week.   The governance issue is complicated by the ownership structure.  Employee unions, for example, have sufficient ownership to block consolidation and industry rationalization, for example. 

France too is pushing a reform agenda.  Economic Minister Macron omnibus bill is to be voted on by the lower house of the French parliament later today.  Although the bill is consistent with a 2007 report he supported as president, Sarkozy has instructed the UMP delegates not to support the pro-business measures.  However, Macron's bigger challenge is not the center-right, but the split among the Socialists about the direction Hollande has tacked with his new pro-business Prime Minister Valls and Economic Minister Macron. 

The measures, dubbed the Macron Law, liberalizes some economic activity in France, including easing lay-offs to the allowing more businesses to operate on Sunday.  It also seeks to weaken the high barriers to entry of certain occupations, including notaries.  It is not clear that the  measures will succeed on the first vote. 

The European Commission has judged that Belgium’s 2.1% budget deficit projection for this year is based on too optimistic of economic assumptions, like 1.5% GDP.   Last year the deficit was about 3.2% of GDP.  The measures Belgium has adopted are mostly structural and expenditure-based.  Previously, the Belgium government has relied on tax increases and one-off measures.

Of the three countries being reviewed by the end of the month, we suspect none will be fined, but France is likely to be the most criticized.