“Decisions have to be made that are not easy and political consensus is needed”

Date:

He suggests the first rate hike could come in July and calls for “credible” measures in the eyes of the markets

Luis de Guindos (Madrid, 1960) became Vice-President of the European Central Bank on 1 June 2018. He did so after being the Spanish minister dealing with the ugliest, a Great Recession that kept Spain’s banking system in check.

From his office in Frankfurt, he confesses that the current situation, despite its seriousness, has nothing to do with how it was then. But there are curves. His recipe for dealing with runaway inflation and war-torn economies is “credibility” in the markets and “prudence” in spending.

– Will interest rates rise in July?

– It will depend on the data and the new economic projections for June. The Governing Council of the ECB decided in April that asset purchases will end in the third quarter. In my opinion, there is no reason why it shouldn’t happen in July. The rates will go up later. How much later exactly is not decided. It could be months, weeks or days.

– But the market is already discounting that there will be two rate hikes this year and there is even talk of a third. Has the pressure to act doubled?

– We are pressured by the data, not the markets. The markets are sometimes wrong.

– There are economists who criticize the excessive sluggishness of the ECB.

– These comments come from the comparison with the US, but the situation in Europe is different. The two main factors that will determine interest rates are the development of second-round effects – wage increases incompatible with price stability – and inflation expectations.

– Does the ECB see the risk of a recession, even out of the corner of its eye?

– The invasion of Ukraine will double inflationary pressures and reduce economic growth. That raw materials and energy rise as they have in practice implies a tax on workers and companies because these factors of production, which are imported, become more expensive. And that ultimately means impoverishment.

As for the risk of a recession, we will have new forecasts in June. What we are already seeing is a sharp decline in growth. But because of the technical definition of a recession – two consecutive quarters of negative growth – we don’t see it now.

– With the withdrawal of incentives, are there countries that may be facing financing problems or budget deficits?

– Nominal government bond yields have risen globally, but risk premiums remain fairly stable. The risk of fragmentation has not materialized, although we are monitoring it. So far we have not seen any tension in this and the situation is not at all comparable to 2011 and 2012.

– Is Spain prepared to implement an interest rate hike?

– The Spanish economy has two strengths. First of all, the financial system is healthy. As a result, banks have continued to provide credit to businesses and households on favorable terms even during the pandemic. In addition, the Spanish economy is competitive, as there has been a surplus on the current account of the balance of payments since 2013.

– And what weaknesses?

– Other two. The first, the tax situation. The government debt-to-GDP ratio is close to 120% and the structural deficit to 5%. Moreover, Spanish inflation, both headline and core, is again above the European average. As the Bank of Spain has warned, operating margins are beginning to be severely affected as Spanish companies’ profitability falls due to the surge in energy and commodity prices.

– Would you advise the Spanish government to take seriously the need for greater fiscal stability?

– My recommendation, not only for Spain, but for all countries with a weaker fiscal profile than others, is that they present credible fiscal plans in Brussels that involve a prudent and sensible process of fiscal consolidation. With these levels of inflation, interest rates will not be as low as they have been in years past, and governments need to prepare. The key, also from the point of view of the markets, is to have credible proposals.

– There is a lot of talk about the extreme dependence that the Spanish economy has on the ECB. In addition to the literature, what is the actual impact, in figures, of all measures taken?

– There are very indicative data. During the pandemic, in 2020 and 2021, the ECB has been buying up €120 billion of Spanish debt on the secondary market each year. This corresponds to Spain’s total net emissions.

European support, including through the Next Generation EU fund launched by the European Council, has been fundamental, especially in an economy like Spain’s. This was the one that fell the most in 2020 and, despite strong growth of 5.1% in 2021, is below the European average and, unlike the rest of Europe, has not yet recovered pre-pandemic income levels.

– Is it sustainable for a government to legally link the increase in pensions to inflation?

– It is a social policy decision and it is not my role to question it. It’s respectable, but it’s clear that it has implications for the sustainability of the system. And that is why such a decision must be accompanied by measures that guarantee the sustainability of the system in the medium term.

– And the salary of civil servants?

– I insist: as Vice-President of the ECB, I cannot intervene in the debate about what a government or a party says or does. In general, you should be careful with the decisions you make. Sometimes, just as important as the measures are the credibility they convey.

– Is it time for wage moderation, for employers and unions to reach income agreements?

– The European and Spanish economies face a complex situation: high inflation, declining growth and reduced margins for companies, which will affect investment and employment. In a situation like this, in which decisions have to be made that are not easy, it would be of great importance that there is as much social and political support as possible for economic policy.

– And do you think Spain is politically prepared to reach that consensus?

– My recommendation is generic. I am not allowed in to judge the case of any particular country.

– Another debate on the table is the tax issue. Is there room to cut taxes in this context of crisis?

– Not all countries are in the same situation. The public sector can play a role in mitigating the impact of war on businesses and families. Although at the same time this can lead to a larger government deficit.

– There are sectors that criticize this statement because a tax cut would fuel inflationary tensions.

– We are talking about temporary and selective measures aimed at the most vulnerable sectors. If the measures are well designed, fiscal policy can help mitigate the impact of an external supply shock like the current one without causing these negative effects on inflation in the medium term. The pandemic has affected many businesses that are now being hit again. In the case of the Spaniards, the drop in margins is very remarkable.

– The health of the financial sector is crucial in a time of uncertainty. Do you think there are countries that still need to make an effort to recapitalize their banks?

– Overall, judging by the capital and liquidity levels of European banks, we are in a much better position than in the past. The pandemic crisis raised much concern about its potential impact on the financial system, but has proved resilient.

– So you are perfectly calm on this matter…

– There are still risks. Nominal interest rates are rising in the markets. This allows banks to have higher profit margins. But it can also affect delinquency. If it goes up, the profitability of the banks goes down. And for banks, the solvency of their customers is of fundamental importance

– Has the evolution of Spanish banking been good enough from a historical perspective? Would you have signed the current photo when you were Minister of Economic Affairs?

– In 2011 and 2012, banking risk was a burden that dragged Spain into a very deep recession. A bailout had to be requested, the old savings banks reformed or Sareb founded, as more than 110,000 million euros in loans to the real estate sector were not repayable.

In 2017, Banco Popular entered a liquidity crisis that ended in a solution. At that point, despite the size of the entity, there is no longer any contagion effect in the financial sector. This shows that the banking situation was already very different after years of reform. And today it is one of the strengths of the Spanish economy.

– As for Banco Popular, in 2011 would it have been possible to arrange it in just a few hours?

– Absolutely impossible.

– Are the calls for mergers of financial entities still on the table?

– Yes, the European banking system has a structural problem of low profitability that needs to be addressed. Profitability has improved in recent months, but this was mainly due to lower provisions. Now that we are in an environment of lower economic growth, it will be necessary to analyze whether this trend is sustainable in the long term or whether other measures are needed.

Source: La Verdad

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