David Grodzki

Energy security in the V4: Assessment of possible cooperation to enhance security and development

Energy security has become one of the most important issues on the agenda of the European Union since the second gas crisis of 2009 when Russian gas flows to Europe were interrupted in the course of Moscow’s dispute with Ukraine over transit fees and higher gas prices. Even though energy security is of importance for the EU as a whole, with the Commission estimating that the import dependency of the Union will reach 73-79 per cent by 2020 and close to 90 per cent by 2030, especially the new twelve member states will be affected by any decision Russia makes about future (oil and) gas exports.1 In particular the Visegrád countries face a number of common challenges that make cooperation within the V4 setting not necessarily obligatory but highly recommendable.

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  1. Note that the security of supply with regards to oil is not covered in this paper due to the fact that oil is a globally traded good with relatively stable costs, regardless of its origin. This allows even the V4 countries to diversify their imports away from Russia to some degree. Nonetheless one should not assume that the situation is significantly better but interconnection is somewhat better and ensures a relatively stable supply of this commodity.

Germany and the crisis of the periphery

Merkel with Commission President Barroso (© Council of the European Union)

Germany has played a major role in every discussion revolving around the current Greek budgetary crisis. Not only has the country been singled out as the biggest creditor, and more generally as Europe’s paymaster, but it has also come under severe criticism for enforcing an export driven economic policy that condemns its European partners to negative trade balances with Berlin. It has been argued repeatedly that Germany is therefore at least partly responsible for the problems faced by countries on the periphery of the European Union. Germany’s chancellor, Angela Merkel has forced crisis-hit countries like Greece, but also Italy, Spain, Portugal and Ireland, to impose severe budgetary cuts and introduce reforms aimed at economic modernisation and labour market liberalisation. The results have been mixed, with the Irish economy clearly recovering and also Spain, Italy and Portugal disappearing from the headlines (and off the radar of most commentators and analysts, it seems). Greece on the other hand has remained in the spotlight and with the second bailout package agreed upon in Brussels recently, rumours have surfaced that a third package might be necessary (though, maybe wisely nobody has yet spoken of any rescue actions after this) to keep Greece from defaulting.

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A story of a renewal gone terribly wrong

NoteAron A. Nemeth wrote an interesting article on the developments in Hungary a month ago (Troubles with Viktor: Latest developments in Hungary). Writing from a different perspective (he is a native Hungarian), I do feel that there is a lot of reason to worry about the state of democracy in Hungary and after recent changes made to the electoral rules (electoral districts were changed to give Fidesz a bigger advantage) and the curbing of the freedom of speech (such as banning newsportal index.hu from reporting from inside the parliament), Hungary is heading down the path of authoritarian countries, leaving the circle of democracies in Europe.


It is a twist of history, the most cruel one imaginable maybe, that a former Communist dissident would turn a democratically ruled country into an authoritarian regime. It is even more ironic if such a regime change should happen within the borders of the biggest democracy promoter in the world.

Unfortunately, this is exactly what is happening right now in Hungary, one of the countries that joined the European Union in 2004. The person in question is the country’s Prime Minister, Viktor Orbán, the man who let Hungary into NATO and promised fundamental changes and a clear break with the past in Hungary.

Since Orbán’s Fidesz party has won the majority of the votes in the 2010 election and ousted the disgraced Socialist government under Prime Minister Gordon Bajnai, who had replaced Ferenc Gyurcsany after the “lies-gate” in 2009, Hungary has undergone a radical change. The party that ran a virtually non-existent campaign by simply distancing itself from the Socialists, has since last April changed the Constitution of the country, declaring the country to be simply “Hungary “instead of the “Republic of Hungary”. It has curbed the authority of the Constitutional Court and removed its competence to rule in questions related to the state budget. It has also adjusted the constituency borders to give itself an electoral advantage over other parties in future elections. Fidesz has nationalised the pension fund and imposed a new media council, staffed with Fidesz cronies, to supervise media outlets. Currently, close to 80% of all media is considered to be Fidesz friendly. Critical outlets, however, such as the popular Hungarian newsportal index.hu have been banned from reporting from inside the parliament building after a satirical take on the government at the end of the year. Last but not least, the government recently decided to impose its authority over the National Bank, thus effectively removing the independent financial supervision in the country. Orbán plans to merge the National Bank with the Financial Regulatory Authority and would thus give the government direct control over the institution.

Hungary on Russia’s path

All this sounds strangely familiar, though recollections of such incidents happening in a democratic country are rare and do not come to mind. It is a very different case when one thinks about the beginning of various authoritarian regimes, and ironically the example of Russia easily comes to mind. Under the presidency of Vladimir Putin (2000-2008), Russia’s government centralised power over all major political bodies, such as the Duma (parliament) which nowadays can hardly be considered to control the government, or the Constitutional Court, which has repeatedly ruled in favour of the government and has been called corrupt and incapable by some of its own judges (see here in Spanish and here in English, and in a very disturbing book by the late Anna Politkovskaya).The media are controlled by the Kremlin and major companies have been brought back under control, often without the consent of their owners. Powerful oligarchs, such as Berezovsky or Chodorkowski ended up in exile or jail, their companies – oil companies Sibneft and Jukos and media outlet ORT, were either nationalised or dismantled and sold off.

The European Commission has repeatedly criticised Russia for its lack of democratic rule and the violation of human rights. When Dmitry Medvedev was elected third President of the Russian Federation, European leaders were hoping that reforms would turn the country into a more democratic country. However, Medvedev has failed to transform the Russian political system. A democratic Russia seems to remains a vision for the distant future.

Back in Hungary

Support for the government has been falling rapidly recently. Only 16 per cent of Hungarians still back the government. More than 80 per cent think the country is heading in the wrong direction. The national currency has been losing around 15 per cent of its value in the past few months. For the second time in a decade the country needs international help to solve its financial problems, provided by the IMF and the EU. However, the situation differs from 2008, insofar that the country’s financial institutions are considered to be no longer independent. The IMF and the EU have announced they would not continue negotiations about a new loan if the government does not loosen its power grab on the National Bank. Hungary might need around 20bn euros, which strengthens the position of the EU and the IMF to force the government to give up its authoritarian campaign.

Even though it seems unlikely that Orbán will admit that the EU still holds certain power over the country’s politics, the government does not find itself in a good position. It has been milking the population with new taxes, international companies are considering moving their assets abroad and the population lost its faith in Fidesz. The country’s credit rating was downgraded by all major rating agencies to “junk” status.

In this situation the country will eventually need help from its European partners. This position of weakness should be exploited by the EU to ensure Hungary returns to the path of democracy. A total overhaul of the changes is not possible but at least the government’s attempts to bring under control the National Bank could be reversed.

This would be a first corrective step. Hopefully it will be the first of many. It would be good for Hungary and the EU. Only a functional system of checks and balances (and this also includes non-classic actors such as the Hungarian National Bank) will ensure democratic rule, a prerequisite for membership in the EU. In the long run Hungary will need the support of its European partners even more to succeed in the international system. The EU, too, could benefit from Hungary, its skilled labour force, its inventors and entrepreneurs

Europe agrees to boost EFSF – possible implications and problems

European Council meeting, 23 October 2011 © Council of European Union
European Council meeting, 23 October 2011 © Council of European Union

Last week brought a breakthrough in the EU’s fight against the lingering eurozone crisis that threatens to bring down the project of the common currency and, as some fear, the whole EU with it. The announcement that European leaders have come to an agreement about boosting the European Financial Stability Facility’s (EFSF) coffers so its lending capacity might be increased to 1 trillion euro. However, this will not be done through an increase in the already existing commitments of Eurozone member states but through the application of a so-called “lever”. Currently the EFSF can lend close to 440bn to countries in need, through “leveraging” another 560bn would be added to it. The EU plans to raise the money from external sources, such as hedge funds, other countries and banks.

Two models are currently considered to boost the EFSF, either:

  • by using the EFSF to guarantee a part of the loan, probably around 25% of the total sum. This would mean that countries willing to invest into a rescue package would have at least part of their investment insured against default. It might be called the insurance scheme. Or
  • throughthe creation of a special purpose investment vehicle (SPIV), in which the EFSF would again guarantee a certain share of the investment. Those SPIVs would be set up individually for every country. It would be used to buy up bonds on the primary and secondary market and would then issue credits to the troubled country. The ESFS would attach a partial-insurance on national government issued bonds, kind of making some of them safer than the rest.

Both schemes would provide only partial insurance for the invested money and it seems very likely that none of them, or a combination of both, will work if Europe will fail to attract investors. However, those will not join any proposals unless they can benefit from it too. Countries like China or Russia, as well as a number of Arab countries, have vast financial reserves and are looking for ways to diversify their portfolio away from the US dollar. However, reaching agreement with them will come at an additional cost.

Who’s going to invest into the EFSF?

China seems like an obvious partner for the EU, as it is heavily dependent on the EU markets and has huge foreign currency reserves, though mostly in US dollars. However, despite this China won’t be an easy partner. The country that has indicated its support for further European integration and its willingness to continue buying bonds of troubled states, such as Portugal, Spain or Greece. Nonetheless, even though this alone might already help to calm markets, it won’t boost the EFSF lending capacity, which means China would have to invest into that tool – most likely when it has been set up as a SPIV. The country’s sovereign wealth fund – CIC – holds up to $400bn and could probably provide around $100bn to support the EFSF. In return for this though China might demand that the EU accept it as a market economy. So far the EU has demanded that China improves its human rights record and the protection of intellectual property rights before it would recognise the country as a proper market economy.

Another potential investor would be Russia, which, benefiting from high energy prices, has been able to boost its budget and might thus be interested to buy into Europe. Unlike China, Moscow won’t bother to push issues such as human rights (think of Chechnya for example). Instead, aware of its important role in securing the EU’s energy security, Russia will urge the EU to open its gas market to Russian companies without having to unbundle its gas monopoly Gazprom. Russia might also target investments in Europe’s high-tech, banking and transportation sector. Unsuccessful attempts, such as the failed take-over bid for Opel in 2009, might then become less likely. Another issue Russia might push for is the visa facilitation for Russians travelling to or through EU territory.

A number of Arab sovereign wealth funds might also be considered as possible partners. However, it seems unlikely that any of them, like the Abu Dhabi Investment fund or the Qatari fund, will invest in the EFSF. This does not mean that there is no desire to help, but their approach is fundamentally different. Similar to Russia and to some extent China, Arab sovereigns have used the crisis to buy into European infrastructure and industries and might target companies such as EADS in return for support of the EFSF.

A number of other actors, such as Brazil, Mexico or India might be potential supporters, however, they will push for a greater role of the developing nations in the International Monetary Fund, a stronghold of US and European interests.

What cost is acceptable to save the Euro?

None of the above mentioned candidates will offer their help for free; however, the cost of accepting such an offer varies strongly. Whereas China’s request to have its economy recognised as a market economy might seem harsh, it actually is less of a big deal than it seems. According to WTO rules China will gain this status in 2016, regardless of what the EU does now. The United States might accept China as a market economy even before 2013. This does not mean that the EU will have to follow suit; however, if the EU wants to engage in horse trading, it should set clear limits. Recognising China’s market status in return for CIC’s involvement in the SPIV does not necessarily mean that the Union will have to refrain from criticising Beijing for its human rights record. However, if China is granted market economy status, this will make it a lot more difficult for the EU to impose anti-dumping measures on Chinese exports and would open up the EU to Chinese investments. Considering that China’s battle chest is filled with at least $3 trillion, Europe’s industries might face a wave of take-over attempts unprecedented in its history.

Russia’s demands seem more modest, however, they are also dangerous and potentially more threatening for Europe’s (energy) security. Russia’s focus is clearly on the essential infrastructure in the field of energy supply, as well as a number of key industries in EU member states. Attempts to buy into a number of big energy suppliers, such as RWE or E.ON, or ENI in Italy, have foundered in the past, but Moscow’s urge to gain access to western knowledge and technology will certainly trigger another wave of proposals to form joint-ventures. Outright attempts to take-over companies might be less likely, though they too cannot be excluded. Maybe the best solution for the EU could be an offer to facilitate the visa requirements for Russian citizens. This would address Russian concerns over the status of Kaliningrad, the Baltic Sea enclave. However, especially the Baltic States might object to any visa facilitation out of fear that this might led to a stronger presence of Russians on their territories.

As far as involvement of Arab or Gulf state sovereign funds is concerned, the question of acceptable costs becomes a bit more tricky to answer as the leaders in the region have taken it upon themselves to use the crisis as a “window of opportunity” to increase their assets portfolio through cheap European additions. There is no reason to object to further investment of those funds in countries hit hard by the crisis – on the contrary. Joint ventures will provide the necessary financial means to invest into infrastructure and modernise it. Neither Qatar, nor Kuwait or Saudi-Arabia have expressed concern over the developments in the EU, as demand for natural gas and oil has so far been largely unaffected by the financial troubles on the continent. The problem might thus be of a different nature. The most interesting targets for the Arab and Gulf state funds will probably be the most sensitive ones for European leaders, such as high-tech, aviation, pharmaceutical or communications companies.

Last but not least, the offer brought forward by Brazil, Mexico and other developing nations to help to bail out specific countries (in this case it was Portugal and, if necessary, Spain) makes them yet another potential candidates to help boosting the EFSF’s lending capacity. Their demand that the developing countries should have a bigger say at the IMF is neither surprising nor unjustified. Even though there has always been an explicit agreement that the head of the IMF should be a European and the deputy director an American, this agreement dates back to the 1940s and is outdated today. It does not take into account the increased importance of developing nations and remains thus essentially “western” in its political outlook. However, should the BRIC states or other developing nations get a much bigger say in the affairs of the IMF, European leaders fear it might get even more difficult to get the institution involved in actions to save European countries, whereas the focus might shift to the needs of other non-European nations.

The conclusion here is somewhat in line with what I wrote about China’s market economy status. It seems almost inevitable that the IMF is going to overhaul its structure and adapt to the new power-constellations in the world, which will have to result in a stronger say of China, India, Brazil or Mexico in international monetary affairs. The institution is undergoing an internal reform already, based on the 2010 agreement of the G20 in October of last year. The European heavyweights France, Germany and United Kingdom will lose some of their votes, whilst a total of 6% of the votes will be shifted to major developing nations such as China. However, this agreement does not foresee a change in the nominating practise that has so far guaranteed the superior influence of Europe and the US on the IMF board.

Leveraging” the EFSF is like playing with fire

Even though the idea of leveraging the EFSF to increase its lending capacity to €1trillion has been welcomed by markets and politicians, it remains a risky and not entirely understandable move. The new “firewall” should be sufficient to discourage markets from betting against smaller economies; however, should Spain or Italy tumble, even the full amount of one trillion Euros won’t be enough to save those countries. The problem is that even though investments into national bonds would be partially insured, this increases the risk of losing all the money in the EFSF. Should a country default and receive a haircut of say 25%, investors might still recover parts of their investment, but the EFSF itself might completely dry up.

To illustrate this, let’s assume a country A is in heavy financial troubles and the EFSF agrees to supply the said country with €400bn, issuing a guarantee for the first 40% of this investment. Countries B and C agree to support the troubled country with the bailout money. Now, despite help from the EFSF, country A defaults and receives a 60% haircut – country B and C would recover their losses, at least the first 40% of their investment from the EFSF guarantee. That’s good for the investor but really bad news for the EFSF, as its own funding would be dramatically reduced.. This also means that the countries behind the EFSF guarantees, those with the best credit rating in the EU, such as Germany or France, would eventually have to refinance the EFSF, risking their own credit rating and gambling with the money of tax payers.

On the other hand, if the EFSF was simply going to buy the debt of a troubled indebted country and that country would receive a haircut, it would still recover a large part of its investment. Usually more than half of the money made available would be retrieved as haircuts seldom exceed more than 50%. This seems like the more desirable option though it also means that the EFSF would only be able to draw on the current €440bn instead of, say, €1 trillion.

How will markets react?

In the past few months a certain choreography has developed between global financial markets and EU actions. Whenever rumours surfaced that a country might be facing financial trouble, the EU insisted that this was an exaggeration and the problems were rather minor. This calmed markets and helped recover the losses of the previous day(s) on the stock market. However, soon afterwards the minor problems actually turned out to be very serious and the EU, sometimes in concert with the IMF, would prepare plans to bail out a troubled economy. Markets tumbled as investors lost trust in the stability of that troubled country, but after a bailout agreement stock markets would be on the rise again. After a couple days of euphoria markets plummeted when analysts de-constructed the agreements and found them either too weak, or unrealistic. The case of the Greek haircut and the boosting of the EFSF triggered exactly the same reaction, however, following Prime Minister Papandreou’s surprise (or shock?) announcement to hold a referendum on the European debt, markets crashed.

Note: I am not an economist and the issue of the EFSF SPIV is among the most complicated models available to boost the bailout funds lending capacity. I hope that I have been able to portray it properly and have understood it correctly, otherwise my conclusions might be flawed. However, as far as the involvement of external investors is concerned, I believe a background in economics to be of secondary importance.