The European Stability Mechanism is an institution that was “born out of a crisis,” noted Luxembourg for Finance CEO during a conversation with the ESM’s managing director on 7 December 2023. Mackel and Gramegna were speaking at a Luxembourg for Finance livestream focusing on events in the past year and expectations for 2024.
Established by the member states of the eurozone in 2012, the ESM is triple-A rated institution and a “lender of last resort” that aims to help euro area countries avoid and overcome financial crises by providing loans or other types of financial assistance to member states in financial distress. During the euro debt crisis, it supported five countries--Ireland, Spain, Portugal, Greece and Cyprus--to the tune of €300bn, explained Gramegna, and as part of the ESM programme, these countries also implemented reforms to tackle the root of their economic issues.
Since the ESM’s founding, we’ve been through several other crises, said Mackel, before asking Gramegna: how do you see the future?
Caution against complacency
It’s completely accurate to highlight that we’re living in a period of “polycrisis,” replied Gramegna, such as the covid-19 pandemic, geopolitical uncertainty due to Russia’s war against Ukraine and high inflation. “We are in a difficult situation,” he admitted.
But “the fact that in 2023, the European Union and the euro area have escaped recession is, in itself, a good result.” The European Commission’s autumn 2023 economic forecast, published on 15 November, projected in both the European Union and the euro area; it expects economic activity to pick up in 2024, with GDP growth forecast to improve to 1.3% for the EU and 1.2% for the euro area.
Does that mean we can be complacent? Certainly not.
“So this is good news. Does that mean we can be complacent?” said Gramegna. “Certainly not. Inflation is still far above the 2% goal of the ECB [European Central Bank]. This year around 5%, next year--2024--around 3% and probably in 2025, slightly above 2%.”
We haven’t yet reached the ECB’s target, despite a slowdown of headline inflation, he noted. Energy prices have not gone up too much and have, in fact, decreased compared to last year, thanks to Europe reducing its dependency on Russia and energy-saving measures. Core inflation--which is when you take out energy and food--sits “stubbornly” around 4%, however, “and we must watch that.”
Geopolitical risks are major concern
We’re facing other risks besides inflation, which Gramegna described as more of a short-term risk. “The highest uncertainty now is geopolitical risks,” he said. “I’ve seen at the IMF [International Monetary Fund] meeting in October in Marrakesh that that was the number one worry of all the countries. And financial markets do not like uncertainty. That will stay with us hopefully not too long, but nobody can really predict that.”
Geopolitical risks then add to the risk of deglobalisation, another topic discussed at the IMF meeting. “International trade contributes less and less to growth around the planet,” said Gramegna. “Trade is a win-win. And if trade goes down, it’s a lose-lose.”
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“The third risk I would like to mention is obviously climate risk, which is one that’s going to stay with us,” he said. The Cop28 conference was being held in Dubai the same week as the Luxembourg for Finance livestream took place, and Gramegna added that he hoped that additional measures would be taken multilaterally, “knowing that Europe has been a leader in this issue and is quite committed.”
Last--but not least--on Gramegna’s list of risks was an aging population. An aging population means issues with pensions, reduced productivity and emphasises the need to spur innovation, he argued.
Markets “quite impressed” with Europe
So how does that affect international investors’ perception of Europe and its economy, asked Mackel. As ESM managing director, Gramegna’s aim is to sell European debt. How are major international investors looking at Europe?
“I think markets are quite impressed by our record in the last two, three years, because a lot of responses came at European level,” said Gramegna. There was the Next Generation EU package--“a great act of solidarity”--which aimed to support the economic recovery from the covid pandemic and build a greener, more resilient, more digital future; there was the Support to mitigate Unemployment Risks in an Emergency (Sure) programme, which helped EU countries fight the economic and social consequences of the pandemic; the European Investment Bank provided guarantees for small and medium-sized enterprises; and the ESM also announced pandemic crisis support.
We have made a collective answer, and that is recognised and seen by markets
“So we have made a collective answer, and that is recognised and seen by markets,” he continued. “But that does, by no means, guarantee that we are completely safe or that we have nothing to do in the future. So no complacency.”
Discussions around the economic governance review are underway, added Gramegna, and “markets expect the European Union to find a solution in order to modernise the stability and growth pact.”
Increasing the resilience of the eurozone
“One lesson we have to learn from the past is that the stability and growth pact was not focusing enough on the need of public investment,” said Gramegna, talking about how to make the euro area more resilient. “In fact, the last 10-15 years, Europe has under-invested compared to the United States, compared to China and others. And so it was, to a certain extent, built into the system.”
“The other one is that the new pact needs to be credible: credible for governments, credible for public opinion and credible for markets. So that will help a lot,” he said. “But there’s quite a lot of other things to be done.”
The first is competing the banking union, and about half of that plan has been achieved, said Gramegna. A single supervisory mechanism of major European banks has been agreed upon and is carried out by the European Central Bank. “That’s working well. In fact, the last stress tests of the banks showed that the major banks of Europe have improved their financial capacity and are robust.”
“When we look back at the financial turbulence that we have had in 2023--in Switzerland and in the United States--we have been unscathed in the European Union, which shows that the efforts in regulation are bearing fruit.”
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“The other one is the single resolution mechanism,” he added. “That is a fund of €80bn that has been collected from the banks themselves to solve the resolution of banks when banks fail, in order to avoid having recourse to taxpayers’ money when banks fail. That’s a great success.”
In addition, “the ESM will add a safety net to those €80bn, and that will be a new role that the ESM will play quite soon, when all the countries will have ratified the new treaty of the ESM.”
Capital markets union and competitiveness
So all that is quite good. “But we still do not have a European deposit insurance system.” This is important because the “depth” of European financial markets is far less than in the US. It’s still “fragmented,” and “that’s why we need to strengthen the capital markets union.”
To do so, regulations on capital markets need to be “harmonised,” said Gramegna. “I’d say this is one of the main items we have to work on.” More international players also need to be attracted to Europe. “If it is too complicated for them, they will probably look for other places to invest.”
The capital markets union is also needed to “enhance the competitiveness of the European economy,” added Mackel.
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“Competitiveness is key,” Gramegna agreed. There has been some good news, he noted: unemployment has reached a record low level since the inception of the euro and total employment is at its highest. But this has not increased productivity.
Technology needs to be better used and innovation needs to be boosted, without forgetting that support for innovation cannot come solely from the government. “Public investment is quite important,” he said. “But we must see how we can crowd in private investment,” which links back to the capital markets union.
“When you see other areas of the world, in particular, the United States--the United States in the last 20 years has had the highest productivity growth. We must inspire ourselves from the good ideas that they have produced there.”
Importance of “European answers”
Mackel’s final question was: are you optimistic for 2024?
“Yes,” Gramegna answered. “I am always optimistic; otherwise, I think I should choose different types of jobs that those I’ve done.”
“What makes me optimistic is that we have proven that Europe can make progress--and even jumps in quality--when there is crisis. As we are in a poly-crisis situation, I am confident that we’re going to find European answers, because the national answers are not sufficient.”