Germany may put end to EU back-slapping party

Self-praise by the bloc's leaders at Davos was premature, as the responses to the zone's debt crises were flawed and new ideas are being stifled by its largest economy

The German chancellor Angela Merkel has slapped down a plan to increase the €440 billion rescue fund and give it new powers. Reuters

The euro is rising again, for now, and business and political leaders at the annual World Economic Forum in Davos, Switzerland, were trumpeting their confidence that Europe has taken the necessary steps to overcome its debt woes.

That is wishful thinking. Behind the public declarations of optimism, officials acknowledge the response to the crisis so far has been flawed, and a furious row is raging about how to prevent it from spreading. Germany, meanwhile, is once again dragging its feet.

Angela Merkel, the German chancellor, has slapped down a plan by the European Commission, the executive arm of the EU, to increase the €440 billion (Dh2.2 trillion) rescue fund and give it new powers.

The commission's proposal, which has the backing of the European Central Bank (ECB), would entail further credit guarantees and cash from solvent EU nations. Further capital commitments from the EU's largest economy, Germany, would be crucial.

The commission argues the rescue fund can at present only lend up to €250bn because it has to maintain huge cash buffers as collateral to ensure it maintains a top credit rating in its bond issues.

Measures taken so far to curb the crisis have failed to convince investors, the commission has argued, and the ECB can't go on indefinitely propping up peripheral nations by buying their bonds to lower their risk premiums.

The rescue fund, known as the European Financial Stability Facility, could relieve the ECB by buying bonds itself, either in the market or directly from high-debt nations.

Officials across the EU are starting to realise that the current way of tackling the crisis - waiting for investors to push countries to the brink and then bailing them out at the last minute - cannot work in the long term.

Greece and Ireland may have been "rescued" but they have been condemned to years of austerity to meet the strict conditions of the bailouts, and will have to service mountains of debt from a shrinking economic base. It is a recipe for years of misery and political instability and will create new divisions within Europe just when the bloc needs to pull together.

More creative methods need to be found to handle the crisis, and boosting the volume of the rescue fund is key to them.

Klaus Regling, the German head of the fund, is even reported to be proposing a scheme of voluntary debt forgiveness for peripheral countries, supported by the fund.

Mrs Merkel has argued that the rescue fund has ample resources and does not need to be increased. And she has made it plain who calls the shots in Europe, telling the commission president Jose Manuel Barroso she will be presenting her own proposals for new measures at the next EU summit in March.

Europe had better hope the crisis does not worsen before that, and that Portugal and Spain, seen as the next possible candidates for a bailout, stay on an even keel because Mrs Merkel's stance over the past year has not been helpful.

Her prevarication was blamed for making Greece so expensive to rescue. And Ireland's sudden lurch towards insolvency was attributed in part to her mixed messages last October, when she aired the possibility of private investors taking a hit in future bailouts.

Now, just when EU officials are starting to become more creative in their response to the problems, Mrs Merkel is slamming on the brakes again. This is partly due to domestic politics. Her conservative Christian Democratic Union (CDU) party has suffered a drop in support over the past year and faces seven tough regional elections this year.

Mrs Merkel's standing as the chancellor and party leader could take a serious knock if the CDU loses power in the rich, south-western state of Baden-Wurttemberg, a bastion of CDU power since 1953, on March 27.

In the run-up to those elections, she cannot afford to do anything that makes her look soft on the high-debt "spendthrift" economies that have failed to live up to Teutonic standards of frugality. An opinion poll released on Friday showed 64 per cent of Germans are against expanding the rescue fund.

Mrs Merkel's hands are also tied by her junior coalition partner, the liberal Free Democratic Party, the opinion ratings of which have dropped rapidly.

It has decided to win back support by becoming even tougher on the euro bailouts. Its parliamentary group passed a resolution two weeks ago stating it would categorically reject any fresh EU measure that would increase the burden on German taxpayers.