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Thursday, July 21, 2011

Reaction to draft EU summit proposal

The Telegraph has got its hands on a copy of the draft EU summit proposals, so here are some of our initial thoughts (not too many new details in them to be honest but gives a base to work from).

On second Greek bailout:
3. We have decided to lengthen the maturity of the EFSF loans to Greece to the maximum extent possible from the current 7.5 years to a minimum of 15 years. In this context, we will ensure adequate post programme monitoring. We will provide EFSF loans at lending rates equivalent to those of the Balance of Payment facility (currently approx. 3.5%) without going below the EFSF funding cost. This will be accompanied by a mechanism which ensures appropriate incentives to implement the programme, including through collateral arrangements where appropriate.
Obviously no figures on how much the bailout will total but most reports put it at €110bn - €120bn (above and beyond the first bailout). Looks like any new bailout loans will have longer maturities and lower rates, interestingly it does read as if this will also be applied retroactively to the original bailout loans (however they were not from the EFSF but on a bilateral basis so the phrasing makes it slightly unclear). Although it’s made clear that the interest rate will stay above the EFSF borrowing cost, you will get to the point where France is paying 3.8% to borrow for 15 years on the market while its underwriting loans so that Greece can borrow at 3.5%. Not sure that this is a sustainable situation or desirable, particularly for French taxpayers.
4. We call for a comprehensive strategy for growth and investment in Greece. Structural funds should be re-allocated for competitiveness and growth under a European "Marshall Plan". Member States and the Commission will mobilize all resources necessary in order to provide exceptional technical assistance to help Greece implement its reforms.
There’s been a lot of talk about this ‘Marshall plan’ for Europe, but details are still thin on the ground. Basically, it looks to encourage other eurozone members to impart expertise to Greece and help its economy return to growth. This is a nice idea but the problem has never really been about knowing what to do, it’s about managing to implement it in a country with growing political unrest and a massively inflexible labour market as well as out-dated infrastructure. We’re also not sure how kindly Greece will take to further intervention in its economy and ultimately its politics as well.
5. Greece is in a uniquely grave situation in the Euro area. This is the reason why it requires an exceptional solution. The financial sector has indicated its willingness to support Greece on a voluntary basis through a menu of options (bond exchange, roll-over, and buyback) at lending conditions comparable to public support with credit enhancement.
The role of private sector involvement (PSI) has been the most hotly debated issue around this summit and unfortunately the draft proposal does little to clear it up. It looks as if they have, as of yet, been unable to agree on the format for PSI and so have stuck with offering a "menu of options". See our previous blogs here and here for discussion of these plans but they all have significant shortcomings.

On the remit of EFSF bailout fund:
7. To improve the effectiveness of the EFSF and address contagion, we agree to increase the flexibility of the EFSF, allowing it to:
- intervene on the basis of a precautionary programme, with adequate conditionality;
- finance recapitalisation of financial institutions through loans to governments including in non-programme countries;
- intervene in the secondary markets on the basis of an ECB analysis recognizing the existence of exceptional circumstances and a unanimous decision of the EFSF Member States.
The key proposal here is that the EFSF looks to be able to lend a bit more freely. It looks to us as if the first bullet point suggests that the EFSF can lend without the need for a full bailout and Memorandum of Understanding (bailout conditions). Combining this with the ability to lend to banks, albeit through governments, basically fills the calls for the EFSF to have a flexible credit line and recapitalise banks. This should help sooth market jitters, but it could also lead to taxpayers underwriting a lot more risky lending. Allowing the EFSF to be tapped more quickly, could mean it needs to be increased in size. The ability to buy bonds on the secondary market had been mooted as a concession to the ECB for its acceptance of a ‘temporary Greek default’.

Given the need for unanimity we doubt it will be easy to agree on the EFSF being used in the bond markets and, given its limited size, it’s unlikely it will ever make a huge dent in the Italian or even Spanish bond market. The main point about all of this is that it requires a rule change to the EFSF, and as such will need approval by the Dutch, Finnish and German parliaments - we're not too sure that will be immediately forthcoming to say the least.

So, those are our initial thoughts on the proposals, all in all nothing ground breaking but they do look to be boosting confidence in the markets. Interestingly, the FTD reports that Finland and the Netherlands are asking for more concrete details on PSI (as are we!). In particular they want a number placed on how much will be raised from PSI in the final summit conclusions. Looks like its still going to be a long evening…


Alan said...

The big question for me is to know by how much the debt/GDP ratio is reduced. I would be really grateful for your take on this.

My worry is that the duration is sent out to 15-30 years, but the principal is not reduced. That is, the fix is a another liquidity elastoplast, rather than a forgiveness of the existing debt (as well as fiscal reductions to live within their means).

A 150% Debt/GDP at the reduced rate of 3.5% still requires a long term *average* GDP growth of 5.25% just to keep on top of the debt. Doesn't seem likely to me.

Unless I have missed something.

Jon Moore said...

Just kicked into the medium length grass again? Greece is already beyond the tipping point where it will not be able to service the (now) larger debt without some sort of write-off, now postponed to sometime never. It will after yesterday find the implementation of structural reforms to its economy, such as the reduction of the state's participation in the economy,impossible and the the die is cast for a rerun in autumn or winter once the (incredibly gullible) markets wake up to the truth of the situation.