The Eurozone Crisis and India-EU Ties

The twelfth India-European Union (EU) Summit is going to be held in Delhi soon. Already indications are that the much hyped broad-based trade and investment agreement will not be signed this time again. It has already missed many deadlines and, it seems, that after announcing some kind of a political or framework agreement, a new deadline will be set again. The recurring postponement of the conclusion of the trade talks has become a regular feature of India-EU Summits. Is it the complexity of negotiations, particularly dealing with products like cars, wines, spirits, pharmaceuticals as well as services trade and procurement which are delaying the agreement? Or it is just a lack of imagination or political will from both sides in the current uncertain European economic climate and policy paralysis in India which is affecting a bilateral deal?

Trade and investment relations with Europe have always been very important for India and formed the core of India-EU relations. With more than US $90 billion bilateral trade, the EU is India’s major trading partner. India’s trade in services with the EU has also grown from about €8 billion in 2004 to about €18 billion in 2010. FDI from the countries of the EU is higher than investments from the USA and Japan put together. Besides, Europe is becoming an important destination for cross-border investments and overseas acquisitions for Indian companies. Encouraged by positive trends, both sides are negotiating for a broad-based bilateral trade and investment agreement since 2007. Achieving this agreement has been one of the major targets of the Joint Action Plan launched under the India-EU Strategic Partnership. Between 2007 and 2009, bureaucrats from both sides lost crucial time without any major achievement. Since then the political economy in both India and Europe has become more complicated. The continuing Eurozone crisis has already started affecting economic ties adversely and is likely to affect them more in the coming years.

Now the two-year-old Eurozone crisis has entered a dangerous phase. The European sovereign debt crisis has grown into one of the biggest challenges the EU has faced in recent times. While the Eurocrats taking charge of Greece and Italy and actions by the European Central Bank (ECB) in recent weeks might give the illusion of some change and stability, but the basic Eurozone problems remain intact. The EU faces a fundamental challenge today which has no easy answers. European policy makers have realized that it is difficult to run a system with a single monetary policy and 27 different fiscal policies. So unless Member States transfer significant fiscal sovereignty to supranational institutions of the EU, the Eurozone crisis is not going to disappear any time soon. Although at the recent European Council meeting, 25 of the EU’s 27 Member States have agreed to join a fiscal treaty to enforce budget discipline, it will take a while before provisions of the treaty are ratified and actually implemented. The Czech Republic and the UK have already refused to sign up.

Interestingly, some of the peripheral countries, particularly Greece, Ireland and Portugal which experienced debt crisis in 2010 were among the best performing countries in terms of growth within the EU over the decade preceding the crisis. The introduction of a single currency led to a sharp fall in real interest rates especially in these peripheral countries as nominal interest rates converged to the low German levels. The credibility of these countries increased as they joined single the currency after fulfilling the so-called Convergence Criteria which included low fiscal deficits (three per cent of GDP), low government debt (60 per cent of GDP), low inflation, low interest rates and stable exchange rate. Further, they also agreed to follow the Growth and Stability Pact which meant continuing to follow these rules. With the improvement in credibility, many west European banks expanded into these peripheral countries. As households and firms borrowed heavily to reap the benefits of growth and enjoy perspective gains in wealth, the demand for credits expanded. The surge in demand for borrowing met with a relaxation in credit supply. Compared to other sectors, construction and financial services grew disproportionately. As a result of high economic activity, there was also an increase in government tax revenues. Rapid growth in the peripheral countries provided a good export market for countries like Germany. As rapid growth led to increased demand for imports, there were large deficits in current accounts which was managed with easy external finance. However, the 2007-08 global financial crisis led to a deterioration of growth performance in the west. As financial tensions led to disruptions in credit, the fiscal and financial burden of the past became unbearable. The revelations that the Greek fiscal deficit was much higher than previously reported focused attention on Greek debt and later also raised doubts about Portuguese, Irish and even Italian debt.

To tackle the issue, the European political elite initiated many unprecedented measures. Along with the IMF, the Euro area member states provided financial support to affected countries in the form of pooled bilateral loans. This included a €110 billion package to Greece; €85 billion assistance to Ireland; and €78 billion financing for Portugal. A second bailout package for Greece worth €109 billion was also agreed with easier repayment terms from the private lenders. They also established a €440 billion European Financial Stability Fund (EFSF), with the mandate of raising funds in capital markets to provide loans to euro area member states which are experiencing difficulty in obtaining financing at reasonable rates. The EFSF may also intervene in the debt primary market. Now with Italy’s problems and the combined debt levels of peripheral countries reaching more than €3000 billion, there are discussions of expansion of the EFSF to € I000 billion. However, realizing these funds is going be a huge task.

Europe has further decided to establish a permanent crisis resolution mechanism, the European Stability Mechanism (ESM) in order to safeguard the Euro and financial stability in Europe. Many scholars and policy makers have also argued for the creation of common Eurobonds backed by all 17 euro area nations. But analysts have already warned that whatever the variant, Eurobonds will only make sense if there is a serious coordination in fiscal affairs and even then only when public debt levels are low. The average expected debt levels in 2012 in the Eurozone are likely to be about 90 per cent of its GDP with the level in Greece reaching 166 per cent and in Italy and Ireland closer to 120 per cent of their GDP. These are much beyond the 60 per cent levels agreed under the convergence criteria.

As a result, the European economic situation still remains murky. There are many reports indicating preparations for a possible Greek exit from the Eurozone. Euro as a currency may not collapse but there is a possibility of a Eurozone break-up with one or more countries voluntarily abandoning the single currency or forced to exit. That is going to be a highly challenging situation for the EU, both legally and practically. ECB studies have shown that while a negotiated withdrawal would perhaps be possible, unilateral withdrawal will be highly controversial and forced expulsion would be almost impossible.

At a broader level, this crisis is part of the global turbulence that began in 2007. It started with a sub-prime crisis in the US, became a global banking crisis, turned into a global recession, and now has become a sovereign debt crisis in Europe. This crisis, however, has not just challenged the European economic integration project, it also has serious implications for its other global ambitions. In the last two decades, Europe has had two major projects – enlargement of the EU from 15 to 27 and successful introduction of the Euro. After its failure to establish a constitutional treaty in 2003 (because of negative referendums in France and the Netherlands), the European elite was successful in pushing the Lisbon Treaty in 2007. The idea behind this treaty was to prepare the EU institutions for an enlarged Union, make its decisions more democratic and above all raising its profile in the world through a newly created European External Action Service and through a new position of High Representative of the Union for Foreign Affairs and Security Policy. Already, the example of an integrated Europe had a powerful appeal to economic policy makers in many parts of the world. The way EU was successfully managing itself, the Europeans also wanted to propagate the concept of “soft power”. It means that in the area of foreign policy, countries could rely more on political and economic tools rather than on military tools. This was in sharp contrast to the American way of managing foreign affairs through military power. However, with the onset of the present crisis, many of these ambitious projects have gone into the background. In the next few years, Europe will be extremely busy in solving its own economic problems.

As the EU is India’s biggest economic partner, India has reasons to be worried. Finance Minister Pranab Mukherjee said recently that ‘If the Eurozone crisis prolongs, growth in exports will be impacted’. But it is not simply a matter of changes in a few trade statistics. In the last 20 years, rising India’s global vision of a democratic, multi-cultural and multi-polar world has coincided with that of Europe’s. Similarly, when the new economic and security architecture is evolving in Asia, Europe’s engagement with it will be incomplete without partnering with India. Realizing the importance, both signed a Strategic Partnership in 2004.

In the past, Indian policy makers have been skeptical of Europe’s role as a major strategic player in Asia. Apart from economic issues, India’s partnership with the EU is still at a “dialogue” level. The reason is that because of the unique nature of the European project, the EU is not able to move strongly on sensitive issues with India. The India-EU FTA could have given some new momentum to bilateral ties. Now with the absence of even an FTA, the main challenge before policy makers from both sides will be to continue justifying the relevance of a strategic partnership to their respective constituencies.

(The author is Associate Professor at the Centre for European Studies, Jawaharlal Nehru University)