Between Cyprus and Italy, the Eurozone is walking on the tightrope
The Eurozone has never looked so fragile. This depends on past and present mistakes, well exemplified by Cyprus and Italy
Despite efforts to signal the solidity and resilience of the Eurozone in the past two years, with new bail-out mechanisms in place and more stringent pacts between the EU and Member States on national public accounts, the Eurozone has never looked so fragile. This depends on past and present mistakes, well exemplified by Cyprus and Italy.
Cyprus is a stumbling story: already ten years ago, it was well known that the small island - whose GDP is worth no more than 1% that of Italy - had turned into a tax haven, mostly by wealthy Brits and Russians. Investments and savings were attracted by generous fiscal treatment and low transparency, coupled with window-dressing of national accounts to meet Eurozone parameters.
When local banks started investing in Greek bonds, reaching an exposure of nine times the island's GDP, Cyprus became a Eurozone problem. After seeking a lifeline in Moscow, in June 2012 the government officially applied for a ?17 bn bail-out, roughly 100% of the country's GDP. No big deal for larger Eurozone countries, and perhaps something that the trojka (EU, European Central Bank and International Monetary Fund) should have "swept under the carpet" without creating further alert. However, the three institutions preferred a more adventurous way: granting a partial bailout (10bn out of 17) and leaving it to the national government to figure out how to raise additional 5.8 billion. This has led to a lottery of puzzling solutions, mostly reliant on a forced "haircut" to national bank deposits - initially involving all account holders, later confined to large-scale deposits (above 100,000 Euros). This merry-go-round has made Cyprus a headline news, and the cause of further turbulence in stock exchanges around the world.
Was this really needed? Especially after the IMF's public mea culpa for its miscalculation of the impact of austerity measures at the beginning of this year, followed by France's resistance to strict Eurozone parameters in February, one would have expected a more nuanced approach to the management of the Cyprus crisis. To the contrary, Germany reportedly stood against a full bail-out - Mrs. Merkel would probably have faced problems justifying such leniency before its constituency.
As global markets raise eyebrows looking at Cyprus, or rather at the awkwardness of the trojka in managing its crisis, the Eurozone increasingly sees the rise of a much more dangerous issue. If Cyprus is a small wound in the Eurozone, Italy is the "sick man" of Europe. After spending one year attached to the international reputation of a "technocrat" government headed by Mario Monti, later turned into an unsuccessful political candidate, February elections have left the country with three coalitions holding a similar share of the votes, hence no clear majority in the Parliament and a clear impasse between going back to the ballot and hoping for acrobatic deals between the democrats and Berlusconi's party (officially declared impossible) or between the democrats and the protesters of the five-star movement (not ready for government, and not wishing to meddle with old politicians).
A solution of last resort is now being sought by the President of the Republic, Giorgio Napolitano, who increasingly looks like a virtuoso violinist on the Titanic: appointing two groups of "wise men" to help tabling a limited set of reform proposals. But the most likely scenario no new government until another round of elections, which means the politically de-legitimated Monti government will remain in place another six months or so: a suspension of democracy that Italian citizens might not digest easily, and that is likely to lead rating agencies to classify Italy's enormous amount of bonds into the "trash" zone very soon.
How many more cases like Cyprus and Italy are we doomed to witness before the Eurozone crisis will be fixed? To be sure, a monetary union can afford neither tax havens, nor haphazard governments. But while the Cyprus problem, due to its small magnitude, should be solved soon, Italy is a different story. Even if the country manages, in the end, to form a government, problems on the way are gigantic and shared by other large EU member states - France above all. During the second half of 2013, this will lead to a massive reaction against Berlin-led austerity policies, and towards more leeway for national industrial policy and growth-friendly reforms. Before German voters go to the ballot in September, Mrs. Merkel certainly wants to keep its country's record high - and currently, polls say she is going to have an easy win again. But soon after, the fact that only Germany grows in a dying European Union will become a major issue. In 2014, the Commission and the Council will have new presidents: expect the unexpected.
Andrea Renda teaches Law and Economics at LUISS Guido Carli university in Rome