borrow on almost the same terms as Germany. However, since the crisis, the borrowing costs had significantly increased.
The ECB has found ways to intervene, even though its statutes do not allow it to act as a lender of last resort. On 6 September 2012, the ECB announced that it would start the Outright Monetary Transactions (OMT) in secondary markets for sovereign bonds in the eurozone, with the aim to lower the borrowing costs of the eurozone countries affected by the debt crisis. The ECB hoped to address severe distortions in government bond markets arising from “unfounded fears (...) of the reversibility of the euro” (European Central Bank, 6 September 2012). In fact, the ECB has undertaken a new function even though its most important task is to guarantee price stability. These two aims – securing low inflation and
low borrowing costs – can be mutually incompatible. Therefore it is important
that the ECB’s focus would not switch from inflation to the borrowing rates. Markets’ reaction to the OMT so far has been positive and the bond rates have lowered and investor confidence has increased. From August till December 2012, a total of 93 bn euros have flown back into the countries hit the hardest by the eurozone crisis (Greece, Ireland, Italy, Portugal and Spain). However, in the first eight months 406 bn euros left the same countries (equivalent of 20% of their total GDP) (Financial Times, 29 January 2013).
The OMT can temporarily alleviate problems, yet it cannot resolve the euro- zone crisis. It can even cause negative effects in case if politicians would become less motivated to implement the necessary structural reforms. The next step in this direction could be Eurobonds. Eurobonds probably could be envisaged in a distant future, when more national policies will be harmonized at the EU level. At the present moment, debt mutualisation would not solve the problem of irrespon- sible spending patterns in certain member states of the eurozone. Therefore, strict conditionality needs to be applied.
Moreover, the ECB does not have “unlimited” resources to invest in government bonds. While the ECB is the only institution that could provide a certain price guarantee for eurozone sovereign bonds, it must be remembered that the total value of eurozone public debts is estimated around 8300 bn euros, which is more than three times the German GDP (Wyplosz, 2011).
2.4 The establishment of a banking union
In order to disentangle the interdependence between sovereigns and banks, it was proposed to establish a banking union. It was clearly a politically more acceptable alternative than the proposals to establish Eurobonds or to move faster to a complete fiscal union. The EC has presented proposals for a single European supervisory mechanism, the first concrete step to a banking union. It suggested the ECB should be entrusted with supervision functions over all 6000 eurozone banks. National supervisors would still continue to play an important
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role in day-to-day supervision and in preparing and implementing ECB decisions (European Commission, 12 September 2012).
The road towards a full-fledged banking union will be difficult. An efficient banking union should include four fundamental elements: banking regulations, supervision, resolution and a deposit guarantee scheme. Yet there are still many unanswered questions currently discussed between the EU institutions and the member states.
Although the final compromise is not yet known, it could be in Latvia’s interests to join the common supervision mechanism. Latvia’s supervision criteria are one of the strictest in Europe, so it would not significantly change the rules. However, it would make banks in Latvia more secure, especially given the growing risk posed by the rapid rise in non-resident deposits.2
2.5 Getting back to growth
With the economies stagnating or even shrinking in many eurozone coun- tries, also the government debts continue to rise. In the southern eurozone countries, it is possible to observe a clear downward spiral. Fiscal adjustment weakens the economies and their revenues are continuing to fall thus causing even further fiscal adjustment measures. There is also a negative link between the crisis in the southern eurozone countries and the more stable eurozone member states: both private sector and households are becoming more reluctant to invest and consume in the economically stronger countries as well (Darvas, 2012). The result is a slowdown or even regression in growth rates throughout the eurozone. The EU’s response to the growth crisis was the “Compact for Growth and Jobs”, adopted on 29 June 2012. It contains many important structural reforms, including restructuration of banking sector, growth-friendly fiscal consolidation, restoring normal lending to the economy and completing the restructuring of the banking sector, modernising public administration, as well as the evaluation of the social consequences (European Council, 28/29 June 2012). A decision was taken to allocate 10 bn euros more to the European Investment Bank, thus increasing its overall lending capacity by 60 bn euros. This unlocked up to 180 bn euros of additional investment across the whole EU. It was also decided to start Project Bond pilot phase that was awarded 4.5 bn euros (European Council, 28/29 June 2012). However, these will have insufficient impact on the overall EU growth. Moreover, measures taken to improve competitiveness may take many years to have tangible effects. Improvements in product market competition usually have effect on growth in three to five years. Reforms in labour market can take even longer – from eight to ten years (Allen and Ngai, 2012).
2 IMF has warned Latvia that “given the size of the sector, a sudden reversal of NDR flows, and the and
the potential of contagion to resident deposits (largely denominated in foreign currency), represents a source of vulnerability to international reserves and a significant contingent fiscal liability (via sovereign backing for the deposit insurance system) ”. (International Monetary Fund, January 2013: 12)