A long meeting of the euro area finance ministers (Eurogroup) concluded without full clarity on some of the important details on the policy decisions already taken at the previous EU summit (28-29 June), including the direct bank recapitalization of banks by the ESM, once the common European supervisor is established (see official eurogroup statement: Eurogroup Statement).
On this issue, the statement indicated that “technical discussions on the future ESM direct bank recapitalisation instrument will start in September so that the ESM could, following a regular decision, have the possibility to recapitalise banks directly once an effective single supervisory mechanism is established.” The statement also indicates that the European Commission (EC) intends to present a proposal for a common supervisor by September and the Council is due to consider the proposal of the EC by the end of 2012.
The decision on who will ultimately take the credit risk for the bank recapitalization by the public sector is key for Spain (and Ireland). Initially, the EFSF loans will go to the FROB and, consequently, those loans will add to the stock of Spanish public debt (at least initially), as any other FROB debt does. According to Bloomberg, political hurdles remain to retroactively move the initial EFSF loans to FROB into a direct injection of funds to troubled banks. French FM Moscovici indicated that “we’ll argue for the retroactivity”. However, German FM Schaeuble said the Spanish government would be liable initially and did not address the issue of eventually converting the loans into direct bank aid.
In our view, the lack of clarity in the Eurogroup statement on this issue likely reflects different views among euro area FMs. Also, the Eurogorup statement indicated again that once the ESM has been established, the EFSF loans to Spain will be transferred to the ESM without gaining seniority status. However, the issue of “seniority status” should become irrelevant, if the European leaders have the intention to retroactively change those loans into direct capital injection.
Also on the details of the new programme for Spain, the statement indicated they will be released on 20 July, including the specific conditionality attached to the loans, as well as the rate and maturity of those loans. Bloomberg, Reuters and several Spanish media (El Pais and Expansion among others) report that the programme will release a first tranche of aid (EUR30bn) by end July to recapitalize some of the troubled banks already intervened by Bank of Spain. The same media also indicated that the loan maturity would be of up to 15yr with an average maturity of 12.5yr.
The statement also indicated that the Eurogroup endorses the EC proposal to delay the Spanish fiscal targets by one year. Several Spanish media outlets indicate that the new deficit targets for 2012-14 will be 6.3%, 4.5% and 2.8% of GDP. In exchange for the acceptance of more realistic fiscal targets, the Spanish government has committed to follow the fiscal recommendations made by the EC, including the presentation of a multi-year budget (2013-14) with specific fiscal measures, increasing VAT starting in 2012 while reducing labour contributions to engineer a fiscal devaluation.
On other issues, the statement lacks details about the possibility for the EFSF/ESM to intervene in secondary bond markets and just recalls the conclusions of the June European Council on the conditionality of such interventions, ie, the respect of the recommendation made under the European Semester (fiscal surveillance macroeconomic surveillance and structural policies). Interventions in the secondary markets had already been made possible after the December 9th European Council, the only new step in that direction is the technical agreement between the EFSF and the ECB, which would act at the agent. However, given that the size of EFSF/ESM has not been increased (total amount of approximately EUR750bn), these interventions would hardly be efficient in the long run. As far as intervention in primary markets are concerned, and in particular regarding the possibility to use the EFSF with a leverage, yesterday’s meeting did not bring any progress even though it is already technically possible to use such a mechanism.
On Ireland, the Communique remains quite unclear about the question of the promissory notes. Ministers acknowledged that the Irish programme is doing well but that “technical solutions” will be required to “Improve its sustainability”. This probably refers to the promissory notes issued in the midst of the crisis two years ago when Ireland had to bail out its banking sector. These notes bear a high interest rate and the Irish government would be happy to replace them by EFSF/ESM loans. The Statement mentions the possibility to open discussions in September, even though this is not explicit (“The Eurogroup will consider the issue again at its meeting in September. Similar cases will be treated equally, taking into account changed circumstances”). During the press conference, JC. Juncker could not really clarify the interpretation of “similar”. Praising Ireland and Portugal for their programme implementation, the chairman of the Eurogroup said without elaborating that “all countries which are in a similar situation will be treated in the same manner.” that being said, the EC spokesman Simon O’Connor said that the EC will make “concrete proposals on improving sustainability of the Irish program” by the September Eurogroup.
Barclays Capital