EFSF’s lending capacity – enough boost to calm the markets?Nov 12th, 2011 | By David Grodzki | Tags: bailouts, ECB, EFSF, Eurozone, Financial crisis
European leaders have hailed the agreement on the European Financial Stability Facility’s (EFSF) capacity boost to one trillion Euro – a milestone to insulate EU member states against future instability caused by markets betting against them. The downward spiral that saw Greece, Portugal and Ireland on the brink of bankruptcy should thus be stopped, and a “contagion” of other countries as Italy and Spain prevented. However, there is no decision yet on how the EFSF’s lending capacity will be increased.
Two options are currently discussed, an insurance scheme and a special purpose investment vehicle (SPIV) scheme.
ñ The first option entails the idea of using the EFSF as a warrantor of loans to other countries. If, say, the EFSF would guarantee a part of those loans (for example 25% of the total) it could boost the total available credit sum to one trillion Euro.
ñ The second proposal would see the creation of an individual SPIV for every country. The EFSF and other international investors, such as hedgefonds, national sovereign funds or states, would join forces to support a country. Such a SPIV would be used to buy up bonds on the primary and secondary market and would then issue credits to the troubled country.
Both schemes could probably be combined, as they share a core element: namely they will protect a part of the “investment”.
Insurance is good for investors, but might be riskier for eurozone countries than any previous move of the EU to bail out troubled countries. Should a country, despite the efforts of the EFSF, default or receive a hefty “haircut”, investors will be able to retrieve the insured part of their investments through the EFSF, but the EFSF itself will be drained off its reserves. Any countries paying into the EFSF will inevitable lose money.
Who’s going to pay?
The most urgent question has not been answered yet: Who is going to finance the “booster”? A number of candidates, such as Russia, China or the IMF, come to mind. Any involvement of an external partner though will come with a political cost. It will determine to what extent the EU will engage with non-domestic creditors.
The most obvious partner would be China, which is desperately seeking to replace parts of its foreign currency reserves away from the US dollar. The Chinese government has been supporting European efforts to bail out Portugal and might buy Italian bonds, and has repeatedly stressed the importance of a strong common currency. Its interest in a strong European economy is self-servicing, as the EU remains one of China’s major markets. If the EU collapses, China’s economy will suffer from the dropping European demand. In return for its support, Beijing will play tough. It might ask the EU to recognise its economic market status, thus making anti-dumping measures more difficult. As China will receive that status in 2016 anyway, another option could be China demanding the EU to refrain from criticising its human rights record, effectively muting the EU.
Another close candidate could be Russia, which might demand a further opening of the EU’s gas market. Moscow might push for Gazprom to acquire shares in downstream distribution infrastructure or shares in EU energy companies. It’s less likely that Russia will bother trying to silence the EU’s criticism of its human rights record, but European leaders might be wary to accept Russia’s terms.
Other countries, such as the Arab and Gulf states, could be considered potential partners, though it’s more difficult to see why they should offer help. Regardless of whether a single state bankrupts or the common currency fails, they will continue to rely on fossil fuels. It therefore seems more likely that these countries might use the opportunity to shop around cheaply and buy into companies and infrastructure.
Another, more interesting group needs to be mentioned. Even though both China and Russia have been discussed in a bit more detail, the role of developing nations might merit more attention. Recently Spain and Portugal appealed to their Latin American partners at the IberoAmerican summit to support their efforts to consolidate their budgets. In what can only be seen as a fantastic twist of history, the former colonies have become a major part of the solution. Countries such as Mexico, Brazil, but also Indonesia and India, might support the EU through the IMF, but will demand a stronger role in the institution. They might force the Europeans to finally break with the traditional division at the head of the IMF – which has always seen a European as its managing director and an American as first deputy managing director. This, however, might mean that the IMF could turn its attention away from the West and focus on other regions.
What about the ECB?
The questions, which parties might join forces with the EU to boost the EFSF and what form it will eventually have, are still unanswered. However, unless the EU decides to engage the European Central Bank (ECB) instead of external partners – a move Germany strongly opposes as it fears this could turn the ECB into a huge bottomless pit feed with German money – it will have to consider the political costs of engagement with potential partners like China or Russia.
It’s difficult to predict an outcome and as the EU has stated that the finance ministers are going to elaborate on the plans till the end of November, it’s hardly more than a guess to claim that this issue is not over yet. Markets will continue to worry, especially over the state of Italy’s budget and Spain, the third and fourth biggest economies in the eurozone. One trillion will not be enough to bail them out. Eventually, I believe, even Berlin will have to give way and consider the ECB option. Why? Because it has (almost) unlimited lending capacities and its current reserves alone amount to more than €5 trillion, enough to calm markets and sufficient to save Italy and Spain twice. Furthermore using the ECB would preserve the EU’s room for manoeuvre vis-á-vis China or Russia.
- Why Europe should thank the financial markets
December 17th, 2011
- Stop wasting money, let Greece default
October 11th, 2011
- Call for writers
October 12th, 2012
- Assessing the impact of the Euro-zone crisis on African economies
December 5th, 2011
- December’s Topic of the Month – Where is the red dragon heading to?
December 4th, 2011