Europe needs restructuring argues Pimco

Fixed income manager argues European Stability Mechanism needs to be introduced sooner and the EU budget revised to address underlying debt, increased borrowing costs, potential eurozone contagion, and stave off social unrest.

Latent and manifold threats to the eurozone call for a significant restructuring of Europe’s financial landscape sooner rather later, said institutional asset manager Pimco.

The European Stability Mechanism (ESM), a set of German-led proposals that will make debt sustainability analysis a pre-condition of any future EU bailouts, must be introduced earlier than the planned implementation date of 2013, it argued.

“A thorough debt sustainability analysis, which the ESM is mandated to conduct from 2013 onward, will likely show what markets are discounting today,” said Andrew Bosomworth, executive vice president, Pimco Europe.

Haircuts, increased bank capital raising, and an exchange of old bonds for new bonds backed by AAA-rated European Monetary Union (EMU) countries, may have to be part of the restructuring process, he said.

“Banks and shareholders may not like that, but bailing in the private sector would give politicians in the surplus countries that have to foot the bill credibility with their electorates who resent bailing out banks, Greece and Ireland,” added Bosomworth.

Alongside private sector tightening, the latest findings from Pimco’s European team called for an overhaul to the distribution of the EU budget.

European Council voting rights should be revised “to better reflect countries’ populations and contributions to the budget”, VAT contributions increased, and agricultural subsidies lifted with that capital reallocated to central government budgets to strengthen longevity of the euro area, it argued.

Pimco said that the number of risks facing Europe underpinned the need for long-term, structural reform.

Individual European states are hampered by the lack of exchange rate flexibility needed to restore competitiveness and work off underlying debt, it said.

Drawing historical comparisons, the research pointed out that before EMU, only Germany and Switzerland completed large fiscal adjustments without exchange rate depreciation.

“Some societies may prefer to exit EMU rather than face years of economic hardship,” warned Bosomworth, referring to protests against fiscal austerity and “the apparent inequity of making the broad population suffer while private sector creditors receive their bonds paid back in full”.

Despite the potential exit of some EU economies from the single currency, Bosomworth argued it will survive as a whole.
“We think Europe will muster the political will to keep EMU intact,” he said.

However, contagion was still a real threat requiring more fundamental reform, claimed Bosomworth.

“Without addressing the insolvency issues in Greece, Ireland and Portugal in a timely fashion, contagion could spread to Spain, Italy and Belgium,” he said.
“For the euro to endure, a more comprehensive plan is needed.”

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