The next three weeks will mark uncertain political times in the eurozone. We could see the election of Francois Hollande as the next French president, the first multi-party coalition in Greece as well as some serious debates about early general elections in Germany. An Irish referendum on the eurozone fiscal treaty – and consequently Ireland’s role in the eurozone – will follow shortly after, but may not go ahead on 31 May as originally discussed. The electoral turnout for the elections in France, Greece and Germany might be as uncertain as the impact they will have on market sentiment and the future direction of Eurozone policies.
An election of Francois Hollande in the second round of the French presidential elections on 6 May would certainly shake up the current conservative leadership within the eurozone. As part of his election campaign, he has criticised last December’s fiscal compact which he deems to be too centred on austerity, a result of a strong push from the German Chancellor Merkel. He may aim to renegotiate the treaty and will hope for support from his party’s traditional foreign allies, such as the German SPD. Hollande has also been a supporter of the idea of eurobonds, an option ruled out by the German centre-right government so far. A change to the German government after the next general election in 2013 or even earlier could add momentum to this idea. All German parties from the left of the centre, currently scoring for a combined vote share of around 60% in recent polls, are rather open to the idea of eurobonds, but differ about how the concept should be implemented.
Hollande’s election might also result in tougher regulation of the French financial system. He has openly targeted the banks for additional tax revenue in addition to the EU-wide financial transactions tax backed by Sarkozy. Other measures proposed by Hollande and his party – the French Socialist Party – include a cap on bank service charges, a hike in the tax rate on life insurance products held for less than 8 years, restrictions on stock options as well as revised bonus regulations and a 75% tax rate on annual income above €1 million.
The two main parties backing Greece’s bailout have been recovering from the lows in the polls, but both are still far away from an absolute majority on 6 May. Recent polls see the conservative New Democracy party and the Socialist PASOK party combined at less than 40% of the votes, which might not be even enough to qualify for a renewal of their current coalition. This compares to a combined vote share of 77% in the last elections. All the other parties which are likely to pass the three per cent hurdle and to enter parliament are assumed to reject the agreed spending cuts. At present a coalition government seems to be the only option to form a government, either a grand coalition if the two main parties can increase their vote share further, or a multi-party coalition.
The government in Greece has been changing since the start of the Third Hellenic Republic in 1974 between PASOK and New Democracy, between left and right, but not shared. The interim governments in 1989 and 2011/12 have been the only very short-lasting exceptions. That is, the two-party system in Greece where the winner takes it all will come to an end. Given historic and recent tensions, it may be questioned for how long PASOK and New Democracy would be able to form a stable government. Any other, multi-party coalition may lead to lowest common denominator compromises and populist measures which might diminish the commitment to the imposed austerity and re-define the future role of Greece inside or outside the eurozone. Competition will increase in the political system which has never been a catalyst for coordinated and consensual political approaches across party lines.
The FDP, the junior partner in the German government coalition is currently facing a severe threat to its political existence. Since its very strong result in the general election in 2009, the party has been facing probably the most significant decline of electoral support in reunified Germany’s history. The party has failed to pass the five per cent-hurdle in six federal state elections since 2009, i.e. has not been elected into state parliament. Currently, polls suggest that the party would fail to enter parliament in Schleswig Holstein and, more importantly, North Rhine-Westphalia, Germany’s most populous federal state, as shown in the chart below. Elections in these federal states are due on 6 May and 13 May, respectively. If the FDP fails, the current government might come under considerable pressure to call for early elections, as their democratic legitimacy had already been questioned after the FDP’s most recent electoral failures. An early election scenario brings to memory the outcome of 2005 when North Rhine-Westphalia proved to be the stumbling block for the SPD/Greens government. Gerhard Schroeder’s coalition lost the lead in the state as well as the majority in Germany’s upper chamber, and the chancellor subsequently announced early elections which took place in September at the time. It might not be the base case scenario that early elections are going to happen, but it cannot be completely ruled out for now.
How does all this fit together? Of course, there are no certain conclusions to be drawn from this, as many of the outlined risks and uncertainties would have to materialise first. It might be worthwhile though to end with a little “what if” thought experiment.
- If the commitment to austerity fades from both the core (France?) and the periphery (Greece?) or even only one side, we might see a further increase of political divide in the eurozone. It will be interesting to see how Germany, the eurozone’s watchdog of austerity, will react on such a development. Old alliances within the eurozone might break, and new ones might emerge. A consequence of the weakening support of last year’s fiscal compact may be that rating agencies revise sovereign ratings. A lesson learned from the S&P downgrade of the US and the multiple downgrades of eurozone countries last year is that rating agencies have become increasingly sensitive to political will and ability to foster and enforce fiscal discipline.
- If investors assume that much of the electoral rhetoric translates into policies, they might start discounting for the likelihood of future regulatory changes and policy measures, such as tougher unilateral regulations of a country’s financial system or the softening of fiscal discipline or any related rating downgrades. As pointed out on the blog before, the tail wags the dog when it comes to rating agency actions.
- If early elections in Germany and a change of government in France will take place, they might lead to a leadership vacuum within the eurozone at a time when we are still in the middle of the sovereign debt crisis. Both the German coalition and opposition might become concerned with accommodating the electorate, while the newly elected French president might need time to establish himself alongside a conservative leadership squad in Europe. Politicians have been criticised by commentators as constantly behind the curve in this crisis. The impact of a Franco-German induced leadership vacuum should not be underestimated at a time when markets start becoming increasingly nervous again.