Overcoming Europe's sovereign debt crisis - the road to stability and growth

Ladies and Gentlemen,

I am glad to speak to such distinguished audience today and grateful for the opportunity to provide you with an update over recent developments regarding the sovereign debt crisis and the measures taken.

Over the past days I have spoken to many investors here in New York, who broadly have a rather pessimistic mood about Europe, and they take a negative short-term view. There is no denying that political processes in Europe are complicated and sometimes hard to understand for outsiders. But as you are familiar with complicated processes, like you must be in the UN, I trust you will appreciate the achievements so far and the contours of the way ahead.

The euro zone is at a decisive juncture, not only in its three-year-old debt crisis but in its 13-year-old history. The two are inevitably linked, of course. The short-term symptoms of this crisis have their roots in long-term ailments, both structural and systemic.

Let me begin with the short-term symptoms.

Our latest forecast, confirmed by latest data, shows the EU economy overall is in a (mild) recession. A slow and subdued recovery is forecast to begin from the second half of this year on, and continue over 2012-13. But this will only happen on the condition that confidence gradually returns and decisive policy action is taken.

Of course, the average picture masks large differences between countries, where GDP growth will remain uneven. The same applies for unemployment, while some member states enjoying virtually full employment, with others suffering from rising unemployment. It is unbearably high for young people who need hope, confidence and opportunity for their future.

Essentially, what we are seeing in action is a rebalancing of the macroeconomic imbalances that built up in Europe before the crisis began. Over the last decade, our integrated financial market channelled savings from countries with slow growth in domestic demand into countries with current account deficits, where domestic demand was thriving with credit booms and increasing wages and prices. This applies both within the EU as well as across the Atlantic.

To some extent, this was sign of our integrating EU economy, as some member states were catching up, and for whom the euro allowed better access to international capital markets. But these macroeconomic imbalances were also the root cause of the crisis.

Take those countries with a deficit in their current account on the one hand. While the Greek case has been largely a fiscal crisis, Ireland and Spain suffered mostly from serious imbalances in the form of credit booms and real-estate bubbles. Italy, in contrast, has not experienced a housing bubble and households are not much indebted, while the problem is the public sector debt and sluggish growth even in the boom years before the crisis.

On the other hand, there are countries with a current account surplus. In the first decade of the euro, Germany was still struggling with the costs of unification. It undertook the necessary structural reforms, which had short-term negative impact on domestic demand, leading to low growth rates for several years.Finlandhad its deep economic and banking crisis in the early 1990s.

Ladies and Gentlemen,

Over the past two and a half years, the eurozone has taken unprecedented action to safeguard financial stability and economic recovery in Europe.

Vulnerable member states have stepped up fiscal consolidation and structural reforms. We have built financial firewalls with robust firepower. In addition, the European Central Bank has played an important role to ensure not only monetary but also financial stability.

The European Stability Mechanism, the euro zone's permanent firewall, will become operational shortly. On June 29, euro-zone leaders committed to do what is necessary to ensure financial stability through an effective and flexible use of the existing instruments. The activation of these instruments, which allow intervention in bond markets when necessary, must follow a request by a member state and would be subject to strict conditionality.

To ensure that such interventions help to bring down bond yields in a lasting way, they will only be available for member states that pursue sound budgetary policies, adopt structural reforms for growth and employment, and address macroeconomic imbalances. Conditions are set via the established policy-making processes between national governments and European institutions. This is important to maintaining ownership and accountability of the eventual recommendations and decisions. The European Commission stands ready to design and carry out the surveillance of strict and effective conditionality, as needed. 

Under the premise of conditionality, European Central Bank President Mario Draghi has made it clear that addressing fears that the euro would be reversible does fall squarely within the ECB's mandate. While fully respecting the independence of the ECB, I welcome its readiness to consider further nonstandard measures to repair monetary-policy transmission. The ECB will remain an anchor of stability throughout the crisis.

In addition, the banking sector is being recapitalised, and in many countries, restructured. We have overhauled and strengthened European financial regulation and supervision. We have reformed economic governance in a way that anchors a stability culture in EMU and facilitates sustainable growth.

The EU's comprehensive strategy has contained the crisis - but not yet tamed it. We need to complete our crisis response in three building blocks: stay the course on fiscal consolidation and reinforce growth through structural reforms and enhanced investment.

First, sound public finances are a prerequisite for sustainable growth. Relaxing consolidation could at best provide short-lived relief, but very soon endanger fiscal sustainability in many Member States - especially in the medium and long term.

Some politicians and pundits are promoting the misperception that the EU fiscal framework forces all member states into a 'one-size-fits-all' consolidation straightjacket. But the Pact underlines the structural sustainability of public finances over the medium-term and implies differentiation among the member states according to their fiscal space and macroeconomic conditions.

Second, we need growth-enhancing economic reforms to ensure lasting correction of fiscal imbalances and enhance the credibility of our strategy.

Indeed, macro-economic imbalances have reduced significantly. The largest corrections have been recorded in deficit countries. Consider the three euro-zone countries under full economic adjustment programs:Irelandhas been able to re-access the markets earlier than envisaged. Portugal is seeing stronger-than-expected export growth, which is helping to offset weaker domestic demand. And even in Greece, more has been achieved than is often realized. The current Greek government is committed to reforms and enjoys broad parliamentary backing. Negotiations are ongoing over the future of the Greek economic adjustment programme.

In Spain, the banking-sector program agreed last month should provide for restructured and recapitalized banks that are effectively regulated and rigorously supervised. Spain has also taken measures to create more competitive product and services markets, reform labour laws that have acted as a brake on job creation, and to put public finances back on a stable footing. Italy has done similarly, in conjunction with a far-reaching spending review and pension reform that should put its debt-to-GDP ratio on a declining path by next year.

But surplus countries are also adjusting. For example, the wage agreements concluded in Germanyin the first half of this year foresee an average wage rise of 4.8%.

However, more adjustment is still to come. The remaining accumulated stocks of internal and external imbalances continue to pose a formidable challenge. Some deficit countries still need to achieve surpluses to bring their external debt onto a declining trajectory.

In June, European Union leaders gave clear guidance to every EU country about where they should focus further reform efforts and decided on the Compact for Growth and Jobs to promote investment. The Commission will soon come forward with further proposals on the single market. We want to accelerate trade and investment negotiations with dynamic partners outside the EU.

EU leaders agreed to a capital increase for the European Investment Bank, which is our public investment bank. The EIB could then expand its lending volume, which is a quick and effective way of channelling badly needed financing to the real economy.

As you can see, the EU is doing its part in bringing policies back on track as well as in strengthening its firewalls.

This has created the conditions for our international partners to strengthen IMF resources earlier this year.

We are grateful for the support from the IMF both in terms of financial assistance and of policy monitoring and advice. We count on its continued support should the need arise.

The EU has also been delivering on the G20 commitments both to address imbalances and to implement financial regulatory reform.

Other parts of the world must address their own imbalances and play their full part in implementing the G20 agreements. Only then we will be sure that we have drawn the lessons from the financial crisis and prevented its recurrence.

Ladies and Gentlemen,

Europe is committed to building a genuine economic union to complement and strengthen our existing monetary union. A specific and time-bound road-map for achieving this will be in place by the end of the year, with an interim report in October.

In September, the European Commission will deliver its proposal for a single supervisory mechanism for eurozone banks, which will involve the ECB. Once this is in place, the European Stability Mechanism will be given the power to recapitalize banks directly. That means the funds it provides for this purpose will no longer add to the debt burden of countries already under intense market pressure.

While building "Economic and Monetary Union 2.0," leaders have also agreed to explore the conditions under which it would be rational for European countries to issue debt jointly. The guiding principle has to be that a further mutualisation of economic risk will require a parallel deepening of integration in budgetary decision-making and a fundamental debate about the limits of budgetary autonomy.

Translating this principle into concrete action will not be easy. The choices that lie before us are of fundamental importance to the future ofEurope. As such, all efforts must be made to ensure that they are taken in a way that European citizens consider legitimate.

To conclude, the sovereign-debt crisis has underlined the necessity forEuropeto rebuild and reinforce its economic and monetary union.

All in all, we need both bold short-term actions and clear long-term perspectives to overcome the debt crisis and return to sustainable growth and job creation.

We count on our international partners' support for these efforts that have a bearing for the entire world economy.

Thank you.

| Arriba |

• "Debt, Governance and Growth: A Euro Area Perspective" - Speech by EU Commissioner Rehn (1/6/2011)