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Euro defeat for Merkel? Only time will tell

At first glance, the big winners from Europe's latest euro-saving summit were the leaders of Italy, Spain and France.

world Updated: Jul 02, 2012 07:30 IST

At first glance, the big winners from Europe's latest euro-saving summit were the leaders of Italy, Spain and France.

By banding together in a powerful coalition to challenge Germany, the high-stakes meeting seemed to show, Mario Monti, Mariano Rajoy and Francois Hollande were able to wring major crisis-fighting concessions from a suddenly soft Angela Merkel.

But if the euro zone is still intact years from now, the marathon session in Brussels may be remembered as much for what the German leader extracted from her combative partners as for the bitter policies she was forced to swallow.

"That Monti, Rajoy and Hollande are now happily selling this as a victory says a lot about the diplomatic skills of Ms. Merkel," said Holger Schmieding of Berenberg Bank.

With her plans hinging on parliamentary votes scheduled for hours after the summit, Merkel took an unyielding public stance in advance. That made it appear as if she had retreated, when in fact she may have got much of what she wanted.

Merkel's biggest concession in the early morning hours of Friday was to agree to give the euro zone's new permanent rescue fund, the European Stability Mechanism (ESM), the power to inject aid directly into stricken banks.

According to the post-summit narrative, she flinched after Monti threatened to withhold his backing for a new European "growth pact" Merkel desperately needed to win crucial votes in the German parliament later that day.

Several senior European officials in Brussels told Reuters however that Merkel had in actual fact signalled privately in the days before the summit that she could live with the idea of direct bank recapitalisations.

Her condition was support for one of Berlin's key demands - the establishment of a central supervision authority for banks run by the European Central Bank (ECB).

Agreed in Brussels, the details of how this new authority will work, what powers it will have and which banks it will supervise remain murky.

But its creation may ultimately be seen as a victory for Merkel and her vision of a united, integrated Europe with strict central controls. The loss of sovereignty it implies may only dawn on Monti, Rajoy and Hollande once EU officials put the meat on the bones of the plan in the second half of the year.

"The tone of the summit certainly made it look like a big defeat for Merkel, but on the substance of what was agreed I don't think it was," said Guntram Wolff, deputy director of the Brussels-based Bruegel think tank.

"The direct recapitalisation of banks can only come once this new bank supervisory body is up and running. This has been her strategy all along - yes to aid, but only once the proper controls are in place."

Expectations Management
Despite a hard-line reputation that has turned her into a figure of hate in Greece and led left-wing British magazine New Statesman to anoint her "Europe's most dangerous leader", Merkel has shown an unusual readiness to compromise on short-term crisis-fighting steps recently.

Last month Germany announced it was ready to grant Spain an extra year to reach its deficit reduction targets. German officials also broke a post-war taboo by signalling a tolerance for higher German inflation levels to help their southern European partners.

At the summit in Brussels, Merkel agreed that ESM loans to Spain would not have "preferred creditor status", a step that could slow a flight out of Spanish bonds by private investors.

But concessions to Italy were modest at best, with German officials vigorously rejecting claims by Monti that any future purchases of Italian debt by Europe's rescue fund would come with minimal conditions.

The 120 billion euro "growth pact" unveiled in Brussels was celebrated as a big win for Hollande, who pledged during his campaign for the French presidency to push back against Merkel's austerity policies and find new funds to support recession-hit economies along Europe's southern periphery.

But this victory was more symbolic that substantive. Much of the overall figure will come from already pledged, but unused, EU structural funds.

So why was the summit seen by so many as a major defeat for Merkel? Top-selling German newspaper Bild said the chancellor had been "blindsided" in Brussels, while influential weekly Der Spiegel wrote that she had become a "hostage" to southern euro states.

One reason may have been her need to maintain an ultra-hard line in the days leading up to the summit, to keep sceptical German lawmakers on-side ahead of votes on EU crisis measures on Friday, the last day before parliament's summer break.

Even after agreeing in the days before the summit to direct aid for banks, the EU sources said, the German side insisted it be kept quiet.

Had Merkel signalled a readiness to do a deal beforehand, the large majorities she needed on Friday in parliamentary votes on the ESM and "fiscal compact" on budget discipline may not have materialised.

"Merkel became a victim of her own expectations management," Der Spiegel said on Sunday.

In the end, German lawmakers had only hours to digest the summit results before voting. After threats of a delay and a raucous debate in the Bundestag chamber, they resoundingly backed the new crisis-fighting measures.

Still, more than two dozen deputies from Merkel's centre-right coalition rebelled and refused to support her, in a sign of growing unease in her conservative ranks.

The one area that European leaders did not find time to discuss in detail at their summit - Merkel's nascent drive to push Europe towards a form of "fiscal union" - is likely to dominate the second half of 2012 and could determine Merkel's political fate.

Within weeks, Germany's top court could rule that any additional steps towards closer European integration would require a change in Germany's constitution, or "Basic Law". That could lead to a national referendum on Merkel's pro-integration course.

Regardless, the debate is likely to dominate Merkel's campaign for a third term in the run up to a federal election in the autumn of 2013.

Setting up a common bank oversight authority is a first step towards the closer union Merkel says is needed to save the euro.

But as European leaders move towards finalising a "road map" for such a union by a December deadline, she will have to convince partners like France and the Netherlands, who remain deeply sceptical about ceding sovereignty to Brussels, to go along with her.

"She is still in control," a senior European official said. "But a lot of countries are still waiting for her to spell out the details of her vision. There is a feeling she wants to move faster than others are comfortable with."

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