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EU faces hard decisions after German election pause

By Peter Spiegel and Alex Barker in Brussels
European Central Bank (ECB) headquarters in Frankfurt, Germany.
Hannelore Foerster | Bloomberg | Getty Images

Throughout her election campaign, Angela Merkel, the German chancellor, has insisted the EU's work has not been put on hold until Germans go to the polls on Sunday. But officials in other capitals privately insist many of the hard decisions facing the eurozone will only be taken up after a new government in Berlin is in place.

Some of the most critical challenges facing the single currency are outside the hands of EU decision makers, particularly the teetering Italian government, the survival of which Brussels and Berlin say is their most pressing concern. In addition, some issues that were once viewed as central to the future of a fully integrated economic and monetary union, such as legally binding reform "contracts" between eurozone governments and monitors in Brussels, appear to have become victims of political resistance.

But in two critical areas, the future of eurozone bailouts and the mad dash to complete an EU "banking union", the end of German election season will mark the restart of many of the most fraught debates the single currency has been grappling with for three years.


During a visit to Brussels on Tuesday , Antonis Samaras, Greek prime minister, made clear he expected more help, highlighting November's agreement that calls for bailout lenders to give Greece debt relief once Athens brings in more than it spends, not counting interest on national debt, a "primary surplus" which that Mr Samaras is on track to hit this year.

"If Greece indeed achieves its targets regarding the primary surplus and structural reforms, then all temporary funding problems will be taken care of," Mr Samaras said.

But senior officials in the "troika" of bailout lenders – International Monetary Fund, European Commission and European Central Bank – privately say they are concerned by Mr Samaras's insistence that no new austerity conditions come with new aid, a promise they believe he will not be able to keep.

The differences set up a fight over whether eurozone lenders should take losses on their existing bailout loans to live up to the November deal and what new burdens will be put on Greece in order to keep the programme on track.


Recent sunny economic news, the Portuguese economy grew 1.1 per cent in the second quarter after three years of shrinking, has spurred talk in Lisbon that they may emerge from a €78bn bailout next year with little more than a line of credit to support a move back into the financial markets.

But senior troika officials say there is little chance of Lisbon escaping a second full-scale bailout. Portuguese borrowing costs remain high after July's near government collapse. Even before that self-inflicted wound, many EU and IMF officials believed Lisbon's borrowing needs were too big to meet on its own.

According to IMF figures, Portugal needs to raise €15.8bn next year from the bond market, a number that rises to €24.9bn by 2016 – totals that outstrip most pre-crisis borrowing levels.

Troika officials remain unsettled by July's political upheaval, which left Paulo Portas, deputy prime minister, head of the junior coalition partner and an outspoken bailout critic, in charge of troika negotiations. Mr Portas has asked for easing of Portugal's deficit targets despite the good economic news, even though Portugal received a similar easing last year amid bad economic news.

A second bailout will probably need to be agreed by the end of the year, or early next year at the latest.

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Long the lone eurozone bright spot, there is intensifying pressure to ensure Ireland emerges cleanly from its €67.5bn rescue in December. Talks are under way to provide Dublin a line of credit as a backstop and a deal on what conditions will be attached is expected as soon as next month.

But troika officials remain concerned that even if Ireland exits, there is a risk of bouncing back in. Public-sector salaries remain high and Ireland's debt level is expected to reach 123 per cent of economic output this year, behind only Greece and Italy in the eurozone. Its deficit is projected to be 7.5 per cent, Europe's highest.

While Ireland's economy is one of the EU's most open and Dublin housing prices are rebounding, officials have been surprised at three straight quarters of economic contraction.

Banking union

The next step of creating an EU "banking union", the creation of a powerful authority to shutdown ailing banks, is the most important legislative initiative on the EU's agenda for the end of the year and pits Ms Merkel, who is resisting a strong centralisation of power without changes to EU treaties, against the ECB and the European Commission.

The transfer of sovereign power and financial control are likened in scale to the creation of the euro itself and against expectations, Germany won significant support for its political and legal concerns at a finance ministers meeting last weekend. Few in Brussels imagine an about-turn from Berlin post-election, but officials are hopeful there will be political space for a deal.

Although the European Commission has proposed itself as the top resolution authority, those working on the reforms see that as unlikely. Michel Barnier, the EU commissioner responsible for financial regulation, has so far hinted at more modest compromises, including giving national authorities primary responsibility for small banks.

To provide funds for bank bailouts, senior officials expect the new system to be more closely aligned with the European Stability Mechanism, the eurozone's €500bn bailout fund. This could involve basing the body in Luxembourg with the ESM and providing an ESM credit line as a temporary step before the EU treaties can be changed to give the ESM a more formal role.

Even in Berlin there is quiet acceptance that a compromise is necessary. The open question will be how much control nations cede to the new authority and what Germany will demand to fill the financing gap while a levy on industry builds up the resolution fund.

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