Emerging Market Adviser - Looking ahead

Walter Molano, Guest Columnist

With more than €1 trillion in LTRO funds injected into the European financial system, the concerns about an imminent collapse of the euro are gone.

The European Central Bank (ECB) was able to buy some time, but the continent's underlying problems were not resolved.

It is true that several new governments across Southern Europe are implementing important economic reforms that will address some of the fundamental imbalances. The most notable progress is being made in Italy, where Prime Minister Mario Monti is pushing ahead with key changes to improve labour flexibility and increase the competitiveness of the Italian economy.

Fortunately, Italy's fiscal and current account shortfalls are not as acute as those of its other Mediterranean neighbours. This year's fiscal deficit target is 1.6 per cent of GDP and the current account gap is less than 4 per cent of GDP. However, Italy's debt load at 120 per cent of GDP is extremely high, and the government will need to run significant surpluses to stabilise the economy.

Greece is also pushing ahead with painful reforms as a precondition for its bailout.

Nevertheless, there are deep concerns that Athens will fail to live up to its promises. Elections will most likely take place next month, and there are worries that the opposition will try to abrogate some of the vows that were made. The same thing is taking place in Spain.

Madrid missed last year's 6 per cent fiscal-deficit target by a wide margin, posting a shortfall of 8.5 per cent. The bogey for this year is a deficit of 5.8 per cent, but Spanish Prime Minister Mariano Rajoy recently announced that this would be impossible. Fortunately, he is confident that he will reach a 3 per cent deficit target next year.

Last of all, Ireland called for a national referendum to ratify the new fiscal pact. In return for some assurances that the measures will be passed, Dublin is asking for additional debt relief for its troubled banks. Therefore, the region's situation is far from rosy.

The LTRO or Long-term Refinan-cing Operations programme bought three more years, but European leaders urgently need to implement radical reforms if they want to avert a collapse of the currency union.

There are many problems that need to be addressed. Some countries are on the verge of insolvency and others are fiscally incompetent. However, the biggest problems are the huge variance in competitiveness.

A short jaunt across the Spanish border visibly describes the problem. France is the picture of austerity. The streets are dimly lit. The cars are older. Homes are humble and prices are lower.

Meanwhile, the Spanish side is resplendent with neon. A fleet of new cars grace the highways. Gleaming trains pull into futuristic train stations, and the restaurants are still full. People may complain about the lack of jobs, but most of them are on dole. There is no interest to reduce wage demands or seek lower-paying jobs.

In other words, despite all of the complaints emanating from Madrid, the Spanish continue to live well beyond their means. This is in contrast to the dinginess of the large German cities, where workers have been forced to deal with the harsh realities of life. The LTRO programme provided liquidity, but it was not a solution.

Moreover, the heavy intervention by the state is creating deeper problems for the eurozone.

The first problem is that it is creating a class of senior creditors, comprised by multilateral institutions and central banks, which are deeply subordinating creditors. This was plainly evident in the Greek restructuring, whereby private creditors were forced to swallow inordinate losses in order to allow official credits to remain whole.

The second problem is the abrogation of basic property rights. European bureaucrats are running rampant over creditor rights, gleefully introducing measures that change the rules of the game. Athens's ratification of retroactive Collective Action Clauses, which rewrote bond indentures, will be something that the market will never forget.

Likewise, ISDA's decision not to invoke the credit default swaps contracts, despite the complete violation of bond covenants, will spell the death knell of the credit-protection industry.

All of this says that Europe may soon limit its access to the international capital markets.

Recent bond auctions fared well across most of the continent, but that was because the European banks were recycling their LTRO funds.

Nevertheless, the rest of the planet is shifting its capital to the United States and the emerging world, where there is more respect for basic property rights.

Therefore, the coast is clear for the time being. Investors will still continue to pour money into risky assets. However, the underlying problems in Europe were not resolved. In many ways, they just became worse.

Dr Walter T. Molano is amanaging partner and the head of research at BCP Securities LLC. Email: molano@bcpsecurities.com.