Stage set for Hollande-Merkel showdown at EU summit

BRUSSELS: European leaders will try to breathe life into their stricken economies at a summit over dinner on Wednesday, but disagreement over a plan for mutual bond issuance and other measures to alleviate two years of debt turmoil has already been laid bare.
For the first time in more than two years of debt-crisis meetings, the leaders of France and Germany have not huddled beforehand to agree positions, marking a significant shift in the Franco-German axis which has traditionally driven European policymaking.
Instead, new French President Francois Hollande will meet Spanish Prime Minister Mariano Rajoy in Paris to discuss policy, before the pair travel to Brussels for the 1800 GMT summit, where minds will be focused by the prospect of Greece exiting the currency area.
Germany’s Bundesbank said the situation in Greece was “extremely worrying” and it was jeopardizing any further financial aid by threatening not to implement reforms agreed as part of its two bailouts.
It said a euro exit would pose “considerable but manageable” challenges for its European partners.
Despite fears Greeks could open the exit door if they vote for anti-bailout parties at a June 17 election, Spain, where the economy is in recession and the banking system is in need of restructuring, is at the frontline of the crisis, with concerns growing that it too could need bailing out.
Hollande’s election victory has significantly changed the terms of the debate in Europe, with his call for greater emphasis on growth rather than debt-cutting now a rallying cry for other leaders.
That has set up a showdown with German Chancellor Angela Merkel, who supports growth but whose primary objective is budget austerity and structural reform. While she and former French president Nicolas Sarkozy did not always see eye-to-eye, in Hollande she is faced by someone with a different vision.
At his first EU summit, Hollande has chosen to make a stand on euro bonds - the idea of mutualising euro zone debt - despite consistent German opposition to an idea that has been hotly debated for more than two years.
He will have support from Italian Prime Minister Mario Monti and European Commission President Jose Manuel Barroso, among others. But Merkel shows no sign of dropping her objections to the proposal, which she has said can only be discussed once there is much closer fiscal union in Europe.
The Netherlands, Finland and some smaller euro zone member states support Merkel, setting the stage for what could be a divisive discussion.
“(Euro bonds) are the wrong prescription at the wrong time with the wrong side-effects,” Germany’s deputy finance minister, Steffen Kampeter, said this week, underlining Berlin’s view.
One EU diplomat put it more colorfully: “Introducing euro bonds is the equivalent of ringing the bell for a happy hour so the inebriated can postpone their hangover indefinitely.”
No decisions will be made at Wednesday’s summit, which is intended to promote ideas on jobs and growth ahead of another meeting at the end of June, but it is clear the debate will be intense, not just over euro bonds but over how to rescue European banks and whether to give more time to struggling euro zone countries to meet their budget deficit goals.
Officials tried to play down any prospect of a rift.
“This shouldn’t be a tense discussion because it’s a broad debate about propositions that are on the table. We are not there to negotiate or take decisions,” a French presidential adviser said.
“Germany today is not firmly against euro bonds forever, and that’s what makes a discussion possible. What is the time frame and what (budget) commitments would we require, that’s what the discussion will be based on.”
Having rallied on Tuesday, European stocks dropped 1.6 percent as investors priced in a lack of dramatic policy intervention. Spanish and Italian borrowing costs rose in turn.
A German two-year debt auction gave a stark illustration of how money is dashing for safe havens. Investors snapped up the 4.5 billion euros of paper on offer even though it came with a zero coupon - offering no return at all.
EURO BONDS “ROAD MAP“
Olli Rehn, the European commissioner for economic affairs, threw his weight behind the euro bonds proposal on Tuesday, calling for a “road map” that sets out the legal and fiscal steps needed to deliver the instruments in the years ahead.
Herman Van Rompuy, the president of the European Council, the body which represents EU leaders, said heads of state and government should abandon taboos as they think about the future of Europe and its economic framework.
As well as exploring ways of resolving the sovereign debt problems that have torn the economies of Greece, Portugal and Ireland apart and threaten the stability of the euro, the leaders will assess how to stabilize their banking systems.
Spain is a particular concern, with a number of its banks laden with bad debts incurred by excessive lending during a property boom that has long since turned to bust and still has some way to go before it touches bottom.
One proposal on the table is for the euro zone’s rescue funds to be allowed to recapitalize banks directly, rather than having to lend to countries for on-lending to the banks.
But that is another idea with which Germany is uncomfortable, even though Merkel said on Tuesday a way should be found to dismantle banks across borders, a possible nod to a pan-euro-zone bank restructuring scheme.
The formal summit agenda is jobs and growth, with policymakers touting three ideas they hope will provide near-term stimulus to the euro zone economy, which registered no growth in the first quarter of the year and threatens to slip back into recession.
On Tuesday, agreement was reached with the European Parliament on ‘project bonds’, instruments backed by the EU budget that can be used to finance energy, transport and telecoms projects alongside private sector investment.
There is also a proposal to double the paid-in capital of the European Investment Bank, the EU’s co-financing arm, to a little over 20 billion euros.
The third initiative is to redirect structural funds - money from the EU budget used to help poorer countries improve their infrastructure - to other areas where it might reap more immediate growth rewards.
The figures are vague, and even if all three proposals were to be activated quickly economists and analysts say they will not provide a sufficient shot in the arm to the euro zone and wider EU economy.
“The hard truth is that there are no magic solutions to solving this crisis. We will all have to keep our spending in check, pay off our debts and swiftly introduce healthy reforms. This is what will kickstart growth,” Dutch Prime Minister Mark Rutte said.