Analysis: Euro bailout fund may be inactive after launch

By Jan Strupczewski

BRUSSELS (BestGrowthStock) – Designed with the power to bail out several countries simultaneously, Europe’s 440 billion euro ($550 billion) rescue fund may end up never using that power and conducting few if any operations in the bond markets.

The European Financial Stability Facility, announced in early May at the height of market panic over the euro zone’s debt crisis, is expected to become operational in late July or early August, after the European Union overcomes the reluctance of tiny Slovakia to sign up to the plan.

The EFSF would extend emergency loans over a three-year period to euro zone countries which had difficulty raising funds from the debt markets. It would obtain money for the loans by issuing bonds guaranteed by all euro zone states.

But the countries most likely to seek money — weak states such as Spain and Portugal — appear determined to avoid applying for the loans, which could require them to introduce new austerity measures and would be more expensive than the borrowing costs they currently face in the markets.

Spain attracted strong demand last week for its sale of 6 billion euros of 10-year bonds at a yield of 4.874 percent — below the roughly 5.0 percent that it would pay on three-year loans from the EFS. Madrid looks set to handle a big bond redemption this month with ease, and will then face no major redemptions for the rest of this year.

Portugal saw healthy demand when it sold five-year bonds late last month at a yield of 4.657 percent, and it has no more bond redemptions scheduled this year, only short-term Treasury bills which can be rolled over much more easily.

Madrid or Lisbon may still have to seek emergency aid next year if their austerity programmes run into trouble. But the chances of them using the EFSF may recede further if their budget ratios start to improve as planned. Meanwhile, Greece is already supported by a separate, 110 billion euro bailout.

“European policy makers seem to be of the view that the very existence of the EFSF means that they will not have to use it,” noted Janet Henry, European economist at HSBC, though she added that a lot would depend on whether regional economic growth was strong enough to push countries through their debt problems.


In the absence of any immediate need for the EFSF to bail out governments, speculation has turned to the possibility of it being used to recapitalize some of Europe’s banks.

The results of bank stress tests across the European Union, to be released on July 23, may show a need for additional infusions of billions of euros into weak institutions to prevent them from destabilizing the banking system.

If banks are unable to raise the capital from the markets, national governments are supposed to provide the money. If governments exhaust their funds, they can turn to the EU’s financial safety net, EU Economic and Monetary Affairs Commissioner Olli Rehn said last week.

“It would not be support for the banks directly, but support for the government that has to face the need to recapitalize some banks,” said one euro zone official source who is familiar with the EFSF.

But national governments may well be able to deal with their banks without recourse to the EFSF. Germany’s regional landesbanks are viewed as one potential danger spot, but the German bank rescue fund Soffin still has about 300 billion euros, which is expected to be more than enough.

Spain’s cajas, or regional savings banks, are seen as the other main danger spot. But Madrid says it expects to need less than a third of its 99 billion euro bank restructuring facility to clean up the banking system. About 11 billion euros have already been provided and the government aims to raise the rest of the money it needs, which may total some 20 billion euros, through bond issues. If demand for its debt remains solid, that should be possible without recourse to the EFSF.

So the EFSF may not be asked to extend emergency loans to any country for the foreseeable future. It may therefore not issue any bonds in the markets — or certainly far fewer than the hundreds of billions of euros worth which looked possible a couple of months ago.

Some EU officials would like to see the EFSF borrow a small amount from the markets soon, perhaps 2 or 3 billion euros, simply to demonstrate that it is operational and convince doubters that it could respond quickly to an emergency.

But proponents of this idea concede it may not be possible. Major operational decisions will ultimately be taken by euro zone finance ministers, and countries such as Germany, which is skeptical about allowing the EFSF to play a major fiscal role in Europe, may not approve. The EFSF’s Framework Agreement suggests it would only borrow in response to a specific need.

International Monetary Fund managing director Dominique Strauss-Kahn urged Europe last month to use the EFSF actively to help boost economic growth in the region, rather than merely leave it in place as a safety net.

“The real question is growth and if institutions are created they should serve a purpose and not just a form of security for times of need,” he said.

But there seems to be little appetite among EU policy makers for pursuing this idea at present. Creating the EFSF with its current, limited role was complex and politically difficult, and EU officials are now focused on sensitive talks to review the region’s budget rules and increase economic policy coordination.


The lack of urgent demand for EFSF money means the facility is likely to have little impact on the debt markets, contrary to initial concern that it could issue a flood of bonds that would “crowd out” investment in government debt.

Though bond issuance by the EFSF could theoretically total up to 440 billion euros, more than the annual issuance of any euro zone country, it would likely be spread out over three years, just as bailout payments to Greece are being spread out. And the facility’s size is modest compared to the 5.4 trillion euros of outstanding euro zone government bonds and bills.

“The 440 billion is not much. The crowding out effect would be really minimal,” said Guillaume Menuet, economist at Bank of America Merrill Lynch.

Issuance of EFSF bonds might siphon off some demand from other supranational bonds such as those of the European Commission and the European Investment Bank, analysts said.

But the EU appears to have designed key aspects of the EFSF to reduce concern about crowding out. Bonds issued by the facility would not have preferred status senior to other government paper.

Also, official sources said there would be no particular limits on which bond maturities the EFSF could issue. This suggests the maturities could be spaced out in a way that avoided putting excessive supply pressure on any area of the euro zone yield curve.

Euro zone finance ministers have said they want EFSF bonds to have the highest possible credit rating, triple A. This appears achievable because each country will guarantee 120 percent of its share of the 440 billion euros.

But analysts think yields offered on EFSF bonds will still have to be higher than on paper of the same maturity from Germany, the euro zone’s benchmark borrower.

“The euro zone bond would be cheaper in terms of price than Germany because, even though it would be triple AAA, part of the guarantees would not come from triple A countries,” said Stephane Deo, euro zone economist at UBS.

Some analysts estimate the EFSF would have to pay more than the 20-30 basis point premium which the European Commission pays above German bunds when it borrows to extend loans under its balance of payments facility for non-euro zone EU members.

The yield on EFSF bonds would ultimately depend on which country was seeking emergency aid and the composition of the team of guarantors, since countries in need of assistance would not guarantee the emergency loans themselves.

“I would go for 40 basis points above the German benchmark, because you would have poor performers in there,” said Carsten Brzeski, economist at ING bank.

(Editing by Andrew Torchia)

Analysis: Euro bailout fund may be inactive after launch