Leaders from the nations that share the euro currency are meeting Friday to discuss steps to make the region better prepared for potential crises.
But, the mounting division between the 19 member states is threatening to stall any rapid progress.
What is euro zone reform?
Broadly speaking, it refers to a vast group of measures put forward by the individual countries and discussed at the euro zone level — usually among the member states’ 19 finance ministers.
These measures aim to strengthen the European institutions and make them more resilient to any economic or financial shocks. The urgency for euro reform came about mainly as a result of the sovereign debt crisis in 2011 that led many euro countries into recession.
The main issue when it comes to reform is the necessity to increase the degree of political interconnection among the 19 members.
For instance, one of the debated measures is a European deposit guarantee scheme, which in practical terms would create a Europe-wide fund that would compensate depositors in case a bank should collapse. This idea has faced criticism in countries including Germany, where politicians are not willing to use their taxpayers’ money to help depositors in another European country.
How does this impact markets?
Equity and debt investors in Europe were deeply impacted by the debt crisis, even more so because European institutions were ill-prepared for such an event.
Between February 28, 2011 and September 30, 2011, the main European stock index fell 22 percent.
Concrete steps to fortify European institutions would likely mean the region would be better prepared to deal with any future economic shocks, which is market supportive. This is true not only for European equities and debt, but also for the single currency.
What are some of the measures being discussed?
Strengthening the European Stability Mechanism (ESM) is perhaps the main objective at this point. The ESM is currently the main lender to countries in economic trouble, such as Greece.
The main proposal aims to turn the ESM into something more akin to the International Monetary Fund (IMF), with powers to monitor the different euro economies to ensure they do not get into trouble. According to France and Germany, the ESM should be able to conduct debt sustainability analysis to offer upfront debt restructuring. However, Italy's new government seems critical of handing new powers to the ESM.
There are also proposals to create a euro zone budget and move forward with a banking union.
Under a suggestion made by Germany and France, the EU should channel some of its funds into a basket that would support investments in the euro area. However, the French argue this fund should total hundreds of billions of euros, whereas the Germans believe the figure should be a bit more conservative.
In terms of a banking union, the euro zone finance ministers agreed last week that the ESM should become the backstop to a mechanism that helps failing banks with minimal costs to taxpayers. This should take the form of a credit line of about 55 billion euros ($63.9 billion).
What will be achieved on Friday?
“Reading between the lines, there seems to be very little committed agreements on anything,” Carsten Brzeski, chief economist at ING, said in a note last week after a meeting of euro zone finance ministers. “The only tangible decision taken was to make the ESM a financial backstop for bank resolutions,” he added.
Ricardo Garcia, chief euro zone economist at UBS, also played down the prospect of any big achievements this week. “Expectations are low, the Eurogroup last week lacked a breakthrough, so there won't be any tangible decisions beyond declarations of intent or agreements in principle,” he told CNBC via email.
The June 29 summit had until now been mentioned as a milestone for euro zone reform. And in the last few weeks, France and Germany had come together to present a common plan.
However, there are still other countries that need to be convinced, in particular the Netherlands. A letter was co-signed last week by 11 countries, including the Dutch, that opposed the Franco-German idea of a common euro zone budget.
“The bigger issue in our view is to convince other core countries outside of France and Germany, rather than Italy, to buy into ideas like a euro zone budget,” Garcia said. “France and Germany have spearheaded the initiative, now it's about getting other strong countries on board. That will take time, at least until year end.”