RGE’s Wednesday Note: Has the EMU Skirted Disaster?
In this week’s note we follow up on our topic from last week: Greece. This Monday, European leaders agreed on a new eurozone stabilization mechanism. Although many operational questions remain unanswered, the €750 billion headline number—in addition to the ECB liquidity facilities and QE—should help fight contagion. It is now up to eurozone periphery countries to fulfill the fiscal consolidation requirements. In addition, the relatively high interest rates on joint loans should serve as an incentive for eurozone members to put their fiscal houses in order without recurring to the facility. The relatively difficult approval process for the loan to Greece points in the same direction. In the longer term, the €440 billion common eurozone financing vehicle could eventually be put on a sounder legal basis and further developed into a full-fledged European Monetary Fund.
With respect to Greece, the new EU rescue plan validates RGE’s recent call for replacing the initial fiscal restructuring plan, or “Plan A.” In a recent RGE Analysis, available exclusively for clients, Nouriel Roubini, Arnab Das and Elisa Parisi-Capone make a case for “Plan B”—preemptive debt restructuring for Greece via extending the maturity of the country’s bonds. Under this plan, the three authors argue, the pledged EMU/IMF funds should be used to stave off an interbank run and prevent contagion to other periphery countries that have seen their long-term borrowing costs spike amid further sovereign downgrades. It is important to be clear that if the planned fiscal adjustment under plan A fails to materialize, there might not be enough funding left to implement Plan B; thus, it is better to use official resources to absorb the collateral damage of a debt restructuring rather than wasting official resources to finance the exit of some private investors that will eventually not prevent an unavoidable debt restructuring.
This week’s deal, which initially prompted equity markets to skyrocket and sharply drove down yields on Greek bonds, has two parts. The first is the extension of a €50 billion balance-of-payments facility for eurozone members, financed by the issuance of EU bonds backed by the €141 billion EU budget. The fund will be enhanced by €60 billion for eurozone members and will carry IMF conditionality. The second part of the plan includes a new €440 billion special-purpose vehicle (SPV) guaranteed proportionally by participating eurozone member states. EU Economic Commissioner Olli Rehn said at a press conference that according to the two thirds versus one third formula, the IMF will provide up to €250 billion of the total €750 billion facility. The total financing needs for Portugal, Ireland and Spain until 2012 amount to about €600 billion. Those for Greece amount to about €120 billion.
RGE also has a couple of new pieces out, available exclusively for Direct Access level clients, assessing the implications of the plan for our clients’ portfolios. The first is an RGE Analysis examining the likely fallout from the deal both in FX markets and sovereign debt markets. The second is a Strategy Flash looking at the reaction of European bond markets to the announcement of the plan. Finally, Nouriel Roubini, Arnab Das and Elisa Parisi-Capone discussed what the plan might mean for the other PIIGS countries in a conference call for clients yesterday. For anyone who missed it, the playback audio is available here.
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