Interview with Kathimerini
Interview with Fabio Panetta, Member of the Executive Board of the ECB, conducted by Eirini Chrysolora
17 October 2020
The pandemic emergency purchase programme (PEPP) has so far secured low interest rate borrowing, especially for countries in need such as Italy and Greece. What do you expect to happen regarding the bonds of these countries when the programme ends? Are you worried that they will fall off a cliff?
The pandemic has driven the euro area economy into its deepest economic downturn. The GDP contraction hit double digits in the second quarter, with disinflationary effects. The ECB has therefore taken decisive measures to protect productive capacity and stabilise markets, providing favourable financing conditions for all economic sectors throughout the euro area. This, in turn, has sustained the flow of financing to households and firms, supporting aggregate demand and avoiding a more pronounced fall in inflation.
But we need to continuously monitor the evolution of the pandemic and its economic implications. The resurgence of infections we are seeing in a number of euro area countries is weakening the recovery, especially in the services sector, where the business activity index contracted in September.
This reinforces the need for prolonged economic support from macroeconomic policies. The ECB will conduct net asset purchases under the PEPP until at least the end of June 2021, and in any case until the Governing Council judges that the coronavirus (COVID-19) crisis phase is over. We will reinvest the principal payments from maturing securities purchased under the PEPP until at least the end of 2022. And any subsequent roll-off of the PEPP portfolio will have to be managed to avoid interfering with monetary policy. In any case, we will not allow any tightening of financing conditions that gets in the way of our aim.
Is there a possibility that the PEPP will be extended beyond June 2021? Could its size be increased beyond €1.35 trillion?
The key driver of economic developments is the evolution of the pandemic, which is depressing investment and consumption. According to European Commission survey data, in September euro area households’ savings intentions stood at their highest level on record since the start of the series in 2000. The current pandemic developments are not positive. On top of the direct impact on spending, uncertainty is likely to increase significantly, with adverse effects on both the economic outlook and the balance of risks.
Both actual inflation and expected inflation are already too low. In September the euro area headline inflation rate was negative for the second month in a row (-0.3%), while inflation excluding the volatile energy and food components was 0.2%. ECB staff have projected that inflation will rise to only 1.3% in 2022, but the most recent inflation data show that there is a risk of inflation dynamics being weaker than projected. Market-based inflation expectations are subdued, and consumers’ inflation expectations have also declined continuously since April.
In view of the sheer size of the downside risks, there should not be any doubt about our determination to preserve price stability. We stand ready to adjust all of our instruments, as appropriate, to achieve our objective of bringing inflation back to our medium-term aim in a sustained manner. During the pandemic we have already adjusted some of our instruments, and this has proven to be effective.
Do you feel that the ECB has once again done more than its share during this crisis? Will monetary policy be able to return to normal after such extensive quantitative easing?
The monetary policy and fiscal policy responses have been essential to protect households and businesses during the crisis, thereby facilitating the necessary public health response.
The mistakes that have characterised past episodes have been avoided. Monetary policy and fiscal policy reacted rapidly to the shock and have mutually reinforced each other. Together, monetary policy and fiscal policy have increased confidence.
A shy policy attitude at the present juncture would have the opposite effect. Our bank lending survey suggests that banks would tighten credit standards considerably if public loan guarantee schemes were not maintained. This could make otherwise viable companies and creditworthy households insolvent. Similar consequences could emerge from a tightening of financial conditions.
The only way to normalise monetary policy in the future is to forcefully support the economy now.
Does the Federal Reserve’s change in inflation-targeting pressure the ECB to follow a more accommodative policy?
Our own strategy review is under way and will be an important focus for our work over the next year. Its aim is to make sure our monetary policy strategy is fit for purpose, both today and in the future.
Some global developments that the Federal Reserve has taken into account in its review are also relevant to our current monetary policy. In particular, the marked decline of the “natural” rate of interest – i.e. the rate at which the monetary policy stance is neutral – observed in advanced economies complicates the task of monetary policy, as it reduces the scope for conducting expansionary policy through rate cuts. This has three key implications.
First, it should reduce our tolerance for inflation drifting downwards away from our aim and prompt us to treat our inflation aim as perfectly symmetric. Second, the instruments we have activated in recent years – such as asset purchases and targeted lending to banks – have been key to containing the risk of deflation and should remain in our toolbox; this would have a stabilising effect and reduce the probability that we have to use those instruments again in the future. And third, it indicates that in extreme situations, such as when interest rates are close to the lower bound, it is essential that fiscal and monetary policy reinforce each other.
To what extent does the €750 billion Next Generation EU (NGEU) package facilitate the ECB’s monetary policy?
NGEU can significantly improve the future path of the European economy. The mere announcement of the recovery fund has contributed to a further decline in fragmentation and supporting sentiment.
But now we need to activate NGEU quickly and use it for productive spending – in other words, to finance investment in a context of growth-enhancing reforms. It is crucial that the funds become available in early 2021, to avoid any fiscal cliff effects. And that the resources are allocated to the sectors that can be powerful drivers of growth in the long term. The link between recovery funding and reforms will further empower the multipliers associated with the recovery spending.
How long do you think it will take for the European economy to return to pre-coronavirus levels? What should Europe’s priorities be in this process?
In the first half of the year euro area GDP declined by 15%, and according to the latest ECB staff projections it will return to pre-crisis levels only by the end of 2022. However, the return to more stringent containment measures that we are observing in a number of euro area countries may push this horizon even further away.
Moreover, there is a risk that a slow recovery will exacerbate divergences across sectors and countries: the longer it takes to return to pre-crisis levels, the greater the impact on divergence and inequality. The European fiscal policy response mitigates this risk, but it cannot eliminate it. We need to quickly return to growth.
How could Greek bonds become eligible under the public sector purchase programme (PSPP), and not only under the PEPP, given that they are still not investment grade?
The PSPP follows a clear set of rules about the eligibility of marketable debt securities and implementation modalities; based on the minimum rating requirements, Greek government bonds are not currently eligible for the programme. But we intervened to fight the effects of the COVID-19 crisis with a variety of instruments. The inclusion of Greek government bonds in the PEPP has stabilised financing conditions in Greece. The Greek ten-year sovereign bond yield has dropped markedly since the start of the PEPP, and currently stands at 0.8%, i.e. below pre-pandemic levels.
Greece, an already heavily indebted country, will be burdened with additional debt by the pandemic. Will its debt be sustainable?
Greece has a high debt burden, but the maturity of its debt is very long and the cost of debt servicing continues to be low, as also indicated by the successful recent issuances. The preliminary debt sustainability assessments by the European Commission on the eligibility of euro area countries for the European Stability Mechanism’s Pandemic Crisis Support concluded that Greece’s debt is sustainable.
Measures adopted by the Greek authorities, as well as those agreed with the European Commission, will have to support the recovery of the Greek economy, allowing debt ratios to abate over time. Looking beyond the short term – where fiscal policy has to manage the impact of the crisis – it is crucial that all resources are devoted to increasing the Greek economy’s growth potential and that appropriate investments are accompanied by reforms which support potential growth and long-term debt sustainability.
How do you think the problem of higher non-performing loan (NPL) ratios due to the pandemic crisis should be addressed? In particular, will Greece, which already had a large stock of NPLs before the pandemic, be able to deal effectively with the problem with “Hercules” [the Greek asset protection scheme] or will it need to take additional measures? The Governor of the Bank of Greece has already proposed establishing an asset management company as a next step, a proposal which seems to be viewed positively by the OECD.
The Greek banking sector had an average NPL ratio of 36.7% in the second quarter of 2020. Such high levels of NPLs weigh on banks’ solvency and profitability. This, in turn, hampers banks’ ability to provide new credit to the economy, with negative consequences for economic growth.
The Hercules asset protection scheme will continue to contribute to sustainable NPL disposals and support Greek banks’ efforts to achieve more sustainable NPL levels in the medium term. Nevertheless, even with these accelerated NPL disposals, the resulting NPL levels of Greek significant institutions are likely to remain far above the average for banks under European banking supervision. Against this background, all avenues for NPL reduction need to be examined. First of all, financial sector reforms should facilitate the process of NPL reduction. Further potential additions to the NPL resolution toolkit should also be thoroughly analysed.
The ECB is cooperating closely with all relevant stakeholders on these issues, including the Bank of Greece.
The Greek government recently published its proposal for the new bankruptcy framework, the so-called Debt Settlement and Second Chance Code. What are your views on it? Is it satisfactory? Would it help to put an end to the phenomenon of strategic defaults and restore the payment culture in Greece?
We are currently preparing our formal opinion on this topic. The ECB has had very constructive discussions with the Greek authorities about this major reform. Work is still ongoing on both primary and secondary legislation and on the IT infrastructure, as a significant number of the foreseen processes are envisaged to be conducted electronically. It is crucial that the reform increases the effectiveness of judicial and non-judicial procedures, improves the efficiency of bankruptcy proceedings and simplifies their procedural requirements, and strengthens the payment culture.