The fall-out of central banks attempting to normalise monetary policy continues, with banks in the eurozone also taking a hit, following the collapse of American lender SVB and Switzerland’s Credit Suisse. The question is now whether this may spill over to the governments ultimately guaranteeing many of the deposits held by banks. 

As always, those governments with the highest debt levels will be in the crosshairs. In the eurozone, this brings Southern Europe back into focus.

Germany’s trade surplus has shrunk to the lowest level in two decades

A recent report by Oxford Economics suggests that higher interest rates in themselves should not mean that highly indebted Eurozone governments will get into trouble soon. “If interest rates rise well above expectations, eurozone fiscal performance would be hit hard and force governments into difficult choices. But even in an extreme scenario we think a debt crisis would be avoided.” Last month, Daniel Kral, a Senior Economist at Oxford Economics, explained, “Greece and Portugal have high debts, but spend just 4.5 per cent of government revenues on interest payments.” He even noted that in 2022, “the spread between German and Italian government bond yields has ( … ) narrowed”. 

It remains to be seen what happens when Southern Europe would not only need to deal with higher interest rates, but also with bank failures and the accompanying cost of guaranteeing deposits up to the legally protected level of €100,000. There is still a deadlock on the EU’s proposal for a European Deposit Insurance Scheme (EDIS), which would make stronger Eurozone States help pay for the weaker ones. There are already lots and lots of transfer arrangements within the Eurozone construct, of course, from the European Central Bank’s monetary operations to the European Stability Mechanism. 

Tottering exports 

As ECB President Christine Lagarde herself now warns, “the euro area has suffered a large terms-of-trade loss owing to rising energy prices”. Trade deficits are not in itself a bad thing, but they are when financed with excessive debt. For Italy in particular, this is the case. Despite a few years of very modest trade surpluses before the pandemic, Italy’s trade deficit is back to the deeply negative levels as in the run-up to the Euro zone debt crisis in 2011 and 2012. Meanwhile, Germany’s trade surplus has shrunk to the lowest level in two decades. This further limits the room for Germany to once again act as the saviour, on top of political constraints, as German citizens are not exactly enthusiastic about more eurozone transfer bills. This is particularly true if a bailout for depositors of a German bank (the stock of Deutsche Bank was badly hammered) would be required.

Already last summer, the European Central Bank took measures to deal with a possible fallout from normalising monetary policy on either the banking system or highly indebted eurozone states. As Robin Brooks, the Chief Economist of the international banking federation Institute of International Finance, explains: “The Euro zone already had its SVB moment last summer when ECB hawks realized they couldn’t hike without providing an additional safety net for Italy, given Italy’s refusal to use OMT. So TPI was born. In the US, the issue is SVB and its depositors. In the Euro zone, it’s Italy.” 

The TPI or Transmission Protection Instrument (TPI), is yet another new ECB programme, unveiled in July 2022. Reuters describes it as an “anti-fragmentation instrument […] which allows the ECB to buy unlimited amounts of a country’s bonds if it feels it is being unjustly punished by the market and the turmoil risks disrupting euro area monetary policy”. As opposed to that other ECB programme, OMT, it is not required to sign up for an EU bailout — which would come with conditions to implement reforms and austerity. 

Could Spain be next?

It is not certain that the spotlight will first be on Italy if things really get nasty. Spain may well be another candidate. In Spain, the national social security fund is well shy of being able to cover the payment of pensions, economist Elisabeth Krecke notes, adding, “In 2022, over 224 billion euros was needed, but only 152 billion euros was available. Year after year, the difference is financed by public debt. Currently, Spain’s public debt-to-GDP ratio stands at an explosive 115 per cent. According to forecasts, if nothing changes, it could balloon to 191 per cent by 2050.” 

Spain is losing most of these lawsuits yet refuses to pay up

The Spanish government is currently embroiled in arbitration lawsuits with renewable energy investors, who are dissatisfied over what they see as the Spanish government’s violation of contracts awarding support for renewable energy investment. The contested Spanish government decision to unilaterally trim support arrangements happened about 10 years ago, but the lawsuits are still running. The government is being sued for a whopping 9 billion euro. The trouble is that Spain is losing most of these lawsuits and continues to refuse to pay up, obviously due to the desperate financial situation of the Spanish Treasury. 

Those investors have now set their eyes on seizing government assets, hoping that this may help convince the Spanish government, which is doing almost as poorly when it comes to complying with arbitration rulings as an international pariah like Venezuela. Spain is currently in arrears up to an estimated 700 million euro. On 15 March, in a new blow for Spanish finances, a Dutch court ruled that it was not able to prevent enforcement of the awards outside of the EU. 

In 2013, the Argentine government decided to rent a private plane for a trip by its President abroad, as it feared that creditors would try to seize the official government plane. As a result of the many lawsuits, the Spanish newspaper Vozpopuli speculates this could now also happen with the Spanish government’s official plane, the Falcon.

Is it a positive sign for Eurozone countries to be compared with Argentina — one of the only countries to regress from developed status to developing?