World's best central bank?

Arguably, the European Central Bank (ECB) has become world's best central bank. It again played the role of a skilled fire-fighter in the eurozone debt crisis by flooding the banks with nearly 530 billion euros on 29th February, 2012 in one of the cheapest loans to help avert a dangerous credit squeeze. This was the second three-year long-term refinancing operation (LTRO) of the ECB and 800 banks lined up to borrow a record dollar 529.5 billion Euros at exceptionally low interest rate of 1 percent per annum with the option of paying back all or parts of the loans at any time after one year. It may be mentioned that the ECB had unveiled this kind of funding operation, known as LTROs, for the first time in December, 2011 to counter frozen interbank lending and dampen tensions on eurozone bond market. Most analysts believe that the operation undertaken in the closing part of last year had succeeded in easing funding problems for European banks, which have to deal with 720 billion euros due to mature in 2012. Banks also appeared to have used some of the cheap money to buy sovereign debt of countries such as Italy and Spain. This helped to bring down their bond yields substantially and the ECB may be hoping to see a similar impact from the second operation. In the first operation launched by ECB, 489.19 billion euros had been borrowed by 523 banks. ECB President Mario Draghi has been reported as assuring bankers that there is "no stigma" associated with borrowing from the central bank with - an effort to convince those who feared it would make their financial institutions look desperate in the eyes of investors. His assurance is also aimed at enticing smaller banks to participate in the hope that they would help boost the eurozone economy by lending to small- and medium-sized businesses. While there is a great deal of clarity about the short-term impact of LTROs, it is difficult to assess their effectiveness in the medium to long-term. By injecting more than a trillion euros into the financial system in the space of two months, the ECB has of course banished the threat of an immediate credit crunch. In fact, there are hopes that credit will now start flowing to the businesses and borrowing costs will ease for governments hit by eurozone crisis. The move would also undoubtedly be positive for risk assets and help to support markets as banks would need somewhere to store the resultant excess liquidity. Italian and Spanish bonds, in particular, are likely to benefit in the initial stages. The most positive impact would, however, be the sucking of some heat out of the eurozone crisis and giving governments time to work out sustainable budget and growth policies for affected countries on the periphery of the bloc. Seen from a long-term perspective, it was apprehended that the infusion of ECB liquidity was no panacea to the eurozone's ailing economies. At best, the measure could buy time but cannot replace a functioning interbank market or solve the sovereign debt crisis on a permanent basis. Unless the health of the distressed economies in the eurozone is improved on a sustained basis and underlying solvency issues of banks are addressed, funding stresses could quickly return, forcing the ECB to resort to extraordinary measures once again. There is also a growing realisation that banks in the eurozone are becoming too much reliant on ECB funds and the second LTRO should be the last one to send the signal to the stakeholders that there is a limit to generous behaviour. The ECB has truly played the role of lender of last resort for it cannot remain indifferent to the plight of banks and businesses financial difficulties which are unable to obtain necessary funds elsewhere. Other side-effects of the ECB move are also difficult to ignore. The measure could prove to be somewhat inflationary if overall productivity in the eurozone economies does not respond vigorously to the injection of liquidity. The issue of moral hazard is also involved and must have been studied more thoroughly. Why honest taxpayers in the eurozone should be made to pay through inflation or higher taxes for covering financial mismanagement of the banks or imprudent fiscal policies of certain countries in the region is a tough question which needs to be raised at various forums. So far as Pakistan is concerned, a quicker end to eurozone debt crisis and revival of their economies would certainly be a welcome development as the country is closely linked to most of the countries in the eurozone through trade, aid inflows, provision of services and manpower. Copyright Business Recorder, 2012