FYI | Mar 16 2011
– The eurozone has surprised by suddenly announcing new agreements
– The bail-out fund is now bigger and concessions have been made to Greece
– It's an improvement, albeit still not enough to cover Italy
– But it may yet prove a turning point
By Greg Peel
Last week the world was distracted by MENA uprisings, including planned Saudi protests and the ongoing civil war in Libya. But Europe was suddenly back in the frame again when Moody's made another one of its behind-the-curve ratings downgrades, this time for Spain. The world was reminded that euro-debt yields have pushed out to new records.
Then came the earthquake and subsequent nuclear threat which has understandably taken the limelight. Behind the radiation cloud, European Union leaders have sparked considerable surprise. It's now over a year since Greece hit the headlines and many months since it became apparent the EU bail-out fund and individual budget cuts were not going to be enough. Talk ever since has been of a more permanent, structural solution addressing both immediate issues and possible future issues. In short, the eurozone as a cooperative and the euro as a common currency have been under threat of fragmenting.
Progress has nevertheless been painfully slow. More recently, eurozone ministers have been meeting every week to nut out some sort of plan but arguments and dissent have hampered the process. Were it not for other distractions, the euro may well have slipped further against the US dollar. On Friday night however, as everyone else in the world was glued to their TV screens, substantial progress was suddenly made. Economists had given up any hope of an announcement before the planned March 23-24 EU summit. Germany and France had both indicated as much.
As Danske Bank reports, four important steps were made.
Firstly, the European Financial Stability Fund, which is the fancy name for the bail-out fund, has been increased from E260bn to E440bn. Throw in the existing European Financial Stability Mechanism worth E60bn and the kitty now stands at E500bn. This amount had been previously flagged but there was an issue over not receiving a necessary AAA rating. While it is not exactly clear how, that issue has now been overcome, notes Danske.
Danske suggests that E500bn is enough to cover Greece, Ireland, and Portugal and should also be enough to cover Spain barring any further real estate crash. It is nevertheless not enough to cover Italy if it came to that. And Italy is currently dealing with its own endogenous issues, being the growing resentment of a serial womaniser and party animal for prime minister and the fact Italy imports most of its oil via a cushy little deal with Libya.
Secondly, the EFSF will be allowed to, under specific circumstances, buy eurozone government bonds in the primary market (meaning a form of QE mechanism). This means the EFSF can buy directly from the governments on issue whereas the European Central Bank can only buy bonds in the secondary market. The EFSF can thus buy Greek and Irish bonds right now, except that those governments have not issued any lately.
Thirdly, as a more immediate gesture, the rate of interest being charged by the fund for the E80bn Greek rescue package has been dropped by 1.0% in exchange for a government promise to sell E50bn worth of state-owned assets. The maturity date of the loan has been extended to 7.5 years from 4.5 years. This means an extra E800m Greece doesn't have to pay annually, but as Danske suggests this really just brings the country one step back from the abyss – not to safety.
Ireland was offered the same 1.0% drop if only were it to raise its deliberately low corporate tax rate to levels in line with other European nations, thus generating more income. But the new Irish government has declined, just as the previous one had. Ireland sees its low tax rate as its only potential saviour if it can encourage foreign businesses into the country to help the economy grow out of its crisis.
Fourthly, a “pact for the euro” has been agreed upon and should shortly be finalised. The existing Stability and Growth Pact encouraged eurozone members to keep budget levels within agreed guidelines but did not legislate such. The new pact means members will need to incorporate the EU's fiscal rules into individual legislation and then stick to those rules. Given several nations have already long ago strayed – in some cases some distance – members will have to come up with their own agendas to eventually meet the goals.
Danske notes, nevertheless, that the new pact does not include any mechanism for sanctions, so realistically this new step is still only based on little more than good intentions. The success of the pact basically relies on peer pressure, Danske suggests, which given attitudes to date is a bit of a joke. Let's face it, the EU has seen nothing but one-finger salutes between members all of its existence. The EU rules do cover a raft of fiscal issues including employment, wages, productivity, pensions and financial stability.
Danske had not expected any agreement ahead of the upcoming summit, and the content of what has been agreed upon to date is better than the analysts were hoping for. There are still details missing, but it is assumed the summit will clear those up.
The analysts suggest the new measures are particularly positive for Portugal, which they believe is about to face another credit rating downgrade from Moody's, and positive for Greece and Spain. Ireland has chosen to opt out and Italy is effectively on its own as well, being too big an economy for the members to contemplate. The winners should now see reductions in their credit spreads, Danske believes, and the way has been made more clear for the ECB to raise its cash rate next month as expected.
More importantly, Danske suggests this might just, possibly, represent a turning point in the euro crisis. That still depends on no further negative developments in the larger economies of Spain and Italy.
And of course, there's plenty else to worry about in the world right now.
