Could the UK be asked to contribute to a Cypriot bailout?

As we have noted before, the potential impact of the Cypriot bailout has the capacity to extend well beyond what would be expected of a country accounting for only 0.2% of eurozone GDP.  This impact is now also lapping at the UK shores.

As we flagged up in our press summary today, new Cypriot Finance Minister Michalis Sarris said over the weekend:

"There are indications that London would participate in a package…for a country that has special links with the U.K., if it were necessary, some way could be found to help in a transitional manner."

This comes a bit out of the blue since there has generally been an unspoken agreement - as well as some formal guarantees - that the UK would not participate in any further eurozone bailouts.  That said, the inclination here seems to be that given the historic ties between the UK and Cyprus, the UK may be more willing to contribute – similar to the Irish bailout.

Apart the IMF - which could play a role and to which the UK contributes - there's another plausible avenue: the European Financial Stabilisation Mechanism (EFSM), which the UK partly underwrites via the EU budget. This fund has around €11.5bn left to lend if needed, while there is always the Balance of Payments facility (which we discussed in our paper on Grexit last summer). The EFSM is also decided by QMV although consensus is usually sought since it is politically controversial to activate. In any case, theoretically the UK could still be dragged in.

That said, it seems pretty unlikely and it would be seen as a pretty hostile move – we also imagine other non-euro countries such as Sweden, Denmark and Poland would not be keen to fund a country to which they have few links. Unsurprisingly, the WSJ cites UK diplomats dismissing the prospect out of hand.

But Sarris’ comments are a reminder that the eurozone crisis continues to impact the UK in a number of ways.

Marshalling growth in Europe

If talking about growth could create economic growth then the eurozone would be flying right about now.

The latest in a long line of 'pro-growth' proposals for the eurozone looks to be the creation of a new ‘Marshall Plan’ to provide funding for investment projects in Europe. The plan, according to El Pais, is to attract €200bn in investment from the private sector to fund projects geared towards creating growth particularly in infrastructure, green energy and high technology.

Currently, there are few details on the plan available but the main mechanisms for achieving the funding seems to be:

-          Increase the European Investment Bank capital by €10bn, which it is claimed would boost the lending capacity by €60bn and overall investments by €180bn (we assume by some sort of match funding with the private sector or other public funding)

-          Use the remaining €11.5bn in the European Financial Stability Mechanism (EFSM) as initial capital to be leveraged in the private sector (again in a similar way to above)

Clearly, this would be an EU scheme rather than just a eurozone one with proportionate access and funding. This also means that as a contributor to the EIB and EFSM, the UK would be involved, effectively underwriting a chunk of the financing - which could potentially be controversial in Westminster. Remember that the provision and Treaty change designed to put the permanent euro bailout fund (European Stability Mechanism) on a legally sounder footing while simultaneously giving the UK guarantees that it will not be implicated in euro bailouts in future, is still to be ratified in the UK parliament.

This would of course not be a "bailout" though, but something quite different. We hesitate to pass judgement on such an undefined plan, but here are some of our initial thoughts:

-          In principle this could be a positive idea for Europe - we like the focus of the investment and if it is conducted in the right way, it could be worth the UK participating. However, it's hard not to be slightly sceptical about how Europe tends to go about these kinds of schemes, which could instantly undermine that case.

-         The EU's new found infatuation with leverage seems to continue with this idea (which is strange given its views on financial regulation and the causes of the financial crisis). The lack of detail aside, the numbers in the plan seem stretched, at best.

-          Given the fairly limited contribution of European funds we wonder why the private sector would suddenly be so keen to invest in these projects. The project assumes that there is a glut of unfunded investment projects in Europe but it’s not clear why this new fund would massive ramp up investment over its currently depressed levels – if the private sector isn’t funding these projects now, why or how would the fund change this? 

-          The massive injection of money into the banking sector through ECB lending has failed to stir bank lending to such projects and some have cited a lack of viable, risk-appropriate demand for these types of loans. It is possible that the glut of unfunded programmes is not as large as the Commission believes, so this fund would not be addressing the correct problem. 

-          The EU already provides a huge amount of funding, through mechanisms such as the structural funds, which go to similar aims of development and investment. As we recently pointed out these could be spent much more efficiently and have a larger impact. The EU should focus on improving and reforming its current spending plans before trying to create new huge funds with grand aims. 

-          If this fund does come into place there needs to be a rigorous and clearly defined criteria for providing funding, which should be based solely around the ‘growth’ potential or economic benefits of the plan. The EU has fallen short on this front in many other areas of spending.

-          The areas mentioned for providing growth (infrastructure, green energy and high technology) all sound very promising and beneficial but need a carefully differentiated approach (which isn't happening in the structural funds). For example, in many areas (see Spain and Portugal) infrastructure spending has been high for some time but delivered few growth benefits and little more is needed. As the CAP and structural funds show, mixing in scientific and environmental goals with economic objectives can become very messy. Although green energy and promoting new technologies are laudable aims they may not provide the best returns and may not be the most cost effective investments. The singular aim of growth should dictate investments rather than a convoluted over-arching strategy to attack many problems in Europe.

Unless these issues are addressed, we may just end up with another pot of European money being poorly targeted and failing to address a key problem.

Who's afraid of the big bad bailout fund?

Update - 12:10: Eurozone finance ministers have already reached an agreement and put out a statement. It's pretty much exactly as we expected, with all assigned funds being rolled into the headline lending volume to give the €800bn.

The fact remains though that, even combined, the funds will not be able to introduce more than €500bn in fresh lending. This was the aim all along. In fact, all eurozone finance ministers have done is correct a previous mistake which would have limited the combined lending capacity to €300bn (as originally the treaty essentially specified that only €500bn in loans could be outstanding at any one time). There should be no illusions that this changes almost nothing (we expect not even the markets which have been reacting to every piece of news will be moved much by this). One thing is for certain though this is a clear win for Germany.

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Eurozone finance ministers are meeting today, in what looks to be the most chilled get-together of this group in recent time. They’re set to sign off on an agreement that will see the combination of the eurozone’s temporary and permanent bailout funds, the EFSF and ESM. On paper, the funds have the potential to produce a combined firewall of €940bn. Still far too little if Italy and Spain went, but an impressive sum nonetheless. That is, on paper. In reality they won’t even come close to this.

In an interview with Bild this morning, German Finance Minister Wolfgang Schauble said he didn’t want to “unnerve markets with numbers”, but in a speech in Copenhagen he did just that, saying,

"We have 500 billion euros in fresh money available, together with the programs already agreed for Ireland, Portugal and the new program for Greece. It is about 800 billion (euros). I think it's enough."

Apparently, Schauble reached this number by adding €500bn from the ESM, €200bn from the EFSF, €56bn in bilateral loans to Greece and €60 billion from the third bailout fund, the European Financial Stability Mechanism (EFSM) – which is underwritten by all 27 member states via the EU budget. But much of this cash has already been spent, i.e. the EFSM only has €11bn left, and some of the other money can’t actually be lent out. In addition, the remaining €240bn in unused EFSF capacity will be held back for ‘exceptional circumstances’ until mid-2013.

As we’ve been reminded of time and again, the only thing that matters is effective lending capacity. The real amount of cash that is still available to back stop struggling states, should it come to that, is only around €500bn. Here’s the lending capacity math (courtesy of some excellent analysis by the WSJ):

• Mid-2012 – The ESM will be limited to €210bn (as it will only have €32bn in paid-in capital). Along with the €240bn in ‘exceptional’ funds, this gives a total potential lending of €450bn. (The money which is already out the door should be ignored)

• Mid-2013 – Following a second instalment of capital the ESM will be able to lend €420bn. The ‘exceptional’ funds will be wound down around this point.

• Mid-2014 – All ESM capital paid-in, reaches total lending capacity of €500bn.

(There is one caveat to these figures, in that the eurozone could decide to speed up the paying in of ESM capital if the funds were needed. However, this would likely face significant opposition from the likes of Germany and Finland, and is therefore most certainly a last resort).

So despite Schauble’s comment, euro finance ministers continue to throw various different numbers around, which bear few resemblances to reality. We also note that the French Finance Minister, François Baroin, yesterday floated an unfortunate analogy. He said,

"The bailout fund is a bit like the nuclear weapon in the military domain…It is not intended to be used but to act as a deterrent."

The problem here is that if it’s too big and terrible to ever be used, it’s likely that it won’t ever be used. Even jittery markets will be able to figure out that a large fund which would damage French and German credit ratings if ever extended will never be fully tapped. So clearly some circular logic at play. And let's not forget that it’s still far too small to save Italy and Spain should if worse come to worse.

But at least eurozone ministers can look forward to a quieter Friday than usual...

UK-EU asylum "row": smoke and mirrors?

The British press' preview of today and tomorrow's summit has been partly dominated by an expected "row" between Cameron and the EU over a Commission proposal to water down rules on asylum. The fact that this has been covered in almost every paper from The Sun to The Guardian suggests it is a story that the communications folks in Downing Street wanted us to read. The question is why?

The so-called Dublin Regulation allows member states to send failed asylum seekers back to their first country of arrival in the EU. However, the Commission is pushing to be given the power to invoke a suspension clause to prevent people being sent back to certain countries if they are under "exceptional pressures" from a mass influx of migrants, for example.

These are ongoing negotiations on a proposal dating back to 2008, to which the previous government opted in. The current Home Secretary Theresa May said a couple of months ago that, "We oppose the suspension of transfers under the Dublin regulation." The Labour Government said it was "concerned" about the Commission's suspension clause at the time of opting in but did so anyway, presumably hoping it would be removed during negotiations.

When Downing Street talks up such a "row", it is usually fair to expect it to be followed by a "UK win" - the reports today suggest that Cameron has won French backing for his position. And with EU leaders, at the very same summit, set to discuss a tightening up of the border-free Schengen zone after recent influxes of immigrants from North Africa, it would be miraculous indeed if at the same time they decided to relax rules on asylum seekers.

This is not to say this isn't an issue because the Government could in theory be outvoted as the decision will be taken by QMV (exactly the kind of reason we have been advocating stronger parliamentary scrutiny of opt-in decisions). But what other motives might there be for talking up a UK victory in Europe?

Could it be that Downing Street would rather we didn't focus on another story perhaps? The Guardian reports today on something that could prove far more explosive for the Government. It quotes German officials saying that the UK will need to contribute to the second Greek bailout, over and above its IMF contributions, through the EFSF, for which the UK is partly liable.

"The German legal situation is clear," a German official said. "The EFSM should contribute." Asked whether the UK could veto such a move obliging it to guarantee billions for Greece, the official answered: "I don't understand the question because the decision is taken by qualified majority vote…Everyone is tied to a QMV decision."

The Guardian probably got a bit carried away, as we would be very surprised if the EFSM is activated for a second Greek bail-out (much will depend on how much EU leaders can squeeze out of private creditors under any bail-out plan. Absent private sector involvement - or at least the appearance of it - there's still a risk that the EFSM will have to pick up some of the slack. There's €11.5bn left in the fund). What is true is that the second Greek bailout is still very much an open game, with the theoretical risk of the activation of the EFSM or otherwise still being decided by a majority vote. But this would create a lot of bad blood. For nearly two weeks now Cameron has been saying the EFSM will not be used but, which leads Tory MEP Dan Hannan to suggest that it is in fact the spat over the ESFM that is the fake row.

In any case, this summit might not give us a whole lot of answers. We'll know for sure by 11th July, when EU finance ministers will meet to hammer out the exact details of the second Greek bail-out.

Labour's bail-out confusion

The Guardian yesterday reported that Labour MPs are considering working "with parliamentarians from any party" to limit Britain's involvement in future eurozone bail-outs, in what appears to be an invitation to Tory eurosceptics. Although its demands remain unclear, Labour seems to have in mind some sort of stronger assurance that the UK will be excluded from the permanent eurozone bail-out mechanism (the ESM) and not implicated in further bail-outs from now until 2013 (when the temporary eurozone-only mechanism, the EFSF, expires, alongside the EU-wide EFSM, though the latter's expiration is actually not in writing anywhere).

In essence, it is an attempt by Labour to cause some problems for the Coalition, although, if this involves some Labour MPs genuinely wanting to push the Coalition to take a more proactive approach in Europe, that's probably good news. We don't doubt that many Labour MPs are genuinely starting to worry about where the EU is heading.

But Chris Leslie, the shadow Treasury spokesman responsible for Europe, seems to have got his figures slightly wrong (and the Guardian doesn't seem that interested in getting to the bottom of the issue). This is how the Guardian writes it up:

"Chris Leslie, the shadow Treasury spokesman responsible for Europe, told the Guardian: 'We will be quite prepared to work with parliamentarians from any party to make sure the funds to protect eurozone members is not drawn disproportionately from funds to which Britain contributes. We have already provided more than our fair share.

'We will also work with anyone to make sure the government acts more quickly to introduce a permanent mechanism that draws on only eurozone members.'

He claimed the EFSM had shouldered a third of the bailout costs, even though it was due to provide only 12%."

Leaving aside that it was the former Labour government that actually signed up to the bail-out fund which involves all EU members (the EFSM) - albeit after having consulted the current Chancellor - the 12% seems to have been plucked from thin air. Does Leslie mean that the EFSM (worth €60bn) amounts to roughly 12% of the total eurozone bailout funds, which including the eurozone-only EFSF (€440bn) total €500bn? If so, we're not aware of any rule, written or otherwise, that states that the EFSM is to be used in a way that mirrors its size relative to the EFSF. In any case, combined with the money from the International Monetary Fund (one third of whatever the EU puts up), the 12% figure makes even less sense.

Or Leslie could perhaps be referring to the UK's liabilities under the EFSM (which according to some accounts are around 12%). In fact, this figure varies as it's based on the UK's share of the EU budget which alters annually (the most recent figure we got from the Treasury is nearer 14%). Again, this makes no sense as the figure refers to a liability specific to the UK, not the EFSM as a whole.

So, either Labour is spinning pretty heavily or it doesn't quite grasp the figures.

Why does this acronym-heavy discussion matter? Because a) far too few people who should know better actually understand what's going on, b) with a potential second Greek bail-out looming, there's a growing risk that the bail-out mechanisms are being used to fund governments that will have to default anyway, meaning that loan guarantees turn into losses for taxpayers. If European politicians don't understand the dynamics at work, they're in for an unpleasant surprise (at a time when populism is on the rise in Europe) and c) to say that the EFSM was ever limited to a specific share of the bail-out is to misunderstand the crucial point: the EFSM is decided by majority voting, meaning that it can take on a life of its own. The lesson here is don't give up EU vetoes.