New Years hangover

The New Year in Europe is likely to begin in a similar manner to that in which the last year ended - with yet another crisis summit. European leaders meet in Brussels on January 30 for the first of a series of monthly summits which will continue until the debt crisis is resolved.

Under the leadership of German Chancellor Angela Merkel and French President Nicolas Sarkozy, details of the new fiscal union treaty, hopefully agreed by 26 European Union nations excluding Great Britain, will be worked out.

The treaty, which is designed to impose tighter budget discipline and harsher penalties for countries who break spending rules, will come into force by the middle of 2012.

The cut to Greece's debt should have been wrapped up by the end of 2011, but negotiations with banks over a voluntary 50 percent write-down of Greece's debt have been going very slowly, because the EU and the banks can't agree on the interest rate for government bonds. The deadline has now been extended into the New Year.

Disagreement also reigns within Greece's interim government. Elections have been postponed until late April in order to give the government time to implement reforms and ward off the lingering threat of bankruptcy.

Greece must also negotiate a second rescue package of 108 billion euros ($141 billion) with the European Union and the International Monetary Fund (IMF).

Investors respond to rescue efforts

During the first few months of 2012, crisis-ridden eurozone countries will need around 200 billion euros of fresh capital to replace government bonds and refinance themselves.

The interesting question will be whether or not they succeed in doing that with manageable interest rates. The eurozone rescue fund, which has been topped up to a total of 500 billion euros, could still be too small to prevent a widening of the eurozone debt crisis to large economies such as France.

Attempts to bolster Europe's rescue capacity by encouraging Europe's central banks to lend additional funds to the IMF have so far been unsuccessful. The President of the German Federal Bank, Jens Weidmann, has voiced his opposition to the proposal.

Yet the threats from US credit ratings agencies to downgrade European states hangs over every attempt to manage the debt crisis. Should this threat materialize in the spring, interest rates for government bonds, including German bonds, could rise.

That consequence is not guaranteed, however. In the summer of 2011 US government bonds remained stable in spite of a downgrade.

Center stage for ECB

The European Central Bank (ECB) is set to play a key role in 2012. It is the only state institution in the eurozone which can respond quickly and flexibly to developments in the financial markets.

The ECB is currently charged with stabilizing the European banking system, and has just launched a special offer - unlimited, three-year, low-interest loans for any bank - meant to boost the economy.

In December the ECB authorized a huge 489 billion euros of loans to the eurozone's banks. But so far the banks have not lent the money on to either countries or companies. Instead they are hoarding it and depositing it back to the ECB.

That means that the threat of a credit crunch still hangs over the economy. By June 30, 2012, banks have to increase their capital to prepare for any state payment defaults. Banks defined as "essential to the system" need to raise around 100 billion euros from their owners or the capital markets.

The ECB has rejected a state financing policy in which it would buy state bonds from highly-indebted eurozone countries - which it says is tantamount to "printing money" - warning that the inflation risk would be too great and governments would immediately suspend money saving measures.

ECB President Mario Draghi has decided it would not be viable for the bank to become a last-resort lender to troubled eurozone nations. In a statement to the European Parliament, Draghi said the ECB is coming up with a contingency plan in the event that eurozone nations are downgraded by ratings agencies and the EFSF looses its top credit rating.

Many EU governments are urging the ECB to help rescue some of the more crisis-ridden states on the Mediterranean, but this has been opposed by Germany. It remains to be seen, therefore, how long Draghi will be able maintain his resolve.

Managing the crisis

Against the backdrop of a looming recession in Europe, the eurogroup leader Jean-Claude Juncker has once again urged European states to consolidate their budgets.

Germany's Finance Minister Wolfgang Schäuble has also said that rescue packages can buy troubled eurozone countries time. "But there is no getting around the fact that the debt crisis can only be solved in the countries where it exists," he told German state radio station RBB.

He added that this wasn't a crisis of the common currency, but a crisis of indebted countries.

A major challenge for the European Union will be negotiations over the common budget for 2014-2020 which are supposed to be completed by the end of 2012.

The eight countries who pay more into the EU pot than they get back out have already rejected an initial draft of the budget.

The European Commission had proposed to limit spending over the period to 972 billion euros. The eight countries, including Germany, want to reduce that by 120 billion euros.

EU diplomats are likely walk out of the toughest negotiations, particularly if the thorny issue of a "British rebate" is on the agenda. Since the UK has refused to participate in the new fiscal union, several EU states have called for Britain to scrap the rebate.

British Prime Minister David Cameron is expected to vehemently defend the two-decade-old rebate that returns billions of euros annually to London in place of farm payments to France and Germany.

Foreign policy concerns

Finally, the EU has to protect its relationship with the US, China and other emerging countries in 2012.

All of these countries have demanded further EU efforts to avoid the spread of the euro crisis to the world economy. As yet, however, these countries have apparently done little to prevent this themselves.

With the financial concerns of 2011 looking to be carried over into the New Year, Europe can at least look forward to welcome relief from the eurozone debt crisis in June in the form of the soccer European Championships. We can only hope that, for one month at least, football rather than finances will dominate the headlines.

Author: Bernd Riegert / ccp
Editor: Ben Knight