Q+A-What steps is euro zone taking on debt crisis?

By Jan Strupczewski

BRUSSELS, March 25 (Reuters) – European Union leaders have
agreed on most elements of a “comprehensive” package of measures
addressing the euro zone debt crisis.

Some details remain to be negotiated in the next few months.


EU leaders agreed to raise the effective lending capacity of
the European Financial Stability Facility, the euro zone’s
bailout fund, to its nominal value of 440 billion euros from
around 250 billion currently. The effective capacity is now
lower than the nominal one because of the need to retain the
EFSF’s triple-A credit rating.

The expansion of capacity, along with other changes to the
EFSF’s operations, will only take effect when leaders sign a
formal pact, which they aim to do by June 30.


Finance ministers are to resolve this by end-June. Top euro
zone officials have said an increase in guarantees by all euro
zone countries is the most likely fix. But this might face
opposition in parliaments in some states, particularly Germany
and Finland, where public opinion is against bailouts.

One source of delay is Finland’s elections on April 17; the
Finnish parliament has been dissolved before the polls and
cannot take formal decisions. The populist True Finns party,
which may win a major role in the next Finnish government, is
against raising EFSF guarantees.

However, many analysts believe the EU will if necessary be
able to exert diplomatic pressure on Finland to approve a
decision on the EFSF, as it did with Slovakia when Bratislava
balked at signing up to the EFSF last year.


This will replace the EFSF when that facility expires in
mid-2013. Euro zone leaders have agreed its effective lending
capacity will be 500 billion euros. This will be backed by 80
billion euros of paid-in capital and 620 billion of mostly
callable capital and some guarantees. [ID:nLDE72K2B0]

The division between callable capital and guarantees is
still to be worked out. The 80 billion euros of paid-in capital
will be provided in five equal installments annually from 2013.

Leaders aim to sign the formal pact for the ESM by June 30,
at the same time as the pact reforming the EFSF.


To facilitate any debt restructurings under the ESM,
governments have agreed that all new euro zone bonds issued from
July 2013 will carry Collective Action Clauses — a legal text
that prevents the blocking of a debt restructuring deal by one
bondholder at the expense of others. [ID:nLDE72K2B0]


Interest on EFSF loans will be cut to “to better take into
account debt sustainability of the recipient countries, while
remaining above the funding costs…, with an adequate mark-up
for risk, and in line with the IMF pricing principles”.

The EFSF now charges, for variable rate loans, interest
equal to three-month Euribor (EURIBOR3MD=: Quote, Profile, Research) plus 300 basis points
for loans up to three years and Euribor plus 400 bps for longer
loans. It also charges a one-off 50 bps fee — well above
International Monetary Fund lending rates. The exact size of
cuts to EFSF rates is to be spelled out in the next two months.

The new EFSF rates will be similar to those charged by the
ESM. Finance ministers have agreed the ESM will lend for up to
three years at its financing cost plus 200 bps, and for longer
than three years at plus 300 bps.


The EFSF will be able to buy troubled countries’ bonds when
they are auctioned by the sovereign.

The purchases will be possible only for countries which have
agreed on an emergency aid programme with the euro zone, such as
Greece or Ireland. The buying will not be available to Portugal
unless it has negotiated a bailout.


Euro zone leaders have agreed to extend the maturity of
current bailout loans to Greece to 7.5 years, doubling the
repayment deadline. They also agreed to lower the interest on
their bilateral loans to Greece by 100 bps.

Ireland, which also wants lower loan costs, has not so far
obtained a reduction on its bailout loan interest because it
does not want to “constructively engage” in talks on
coordination of a common corporate tax base.

The issue may be put back on the agenda once Ireland next
week publishes the results of stress tests of its banking
sector, which should reveal whether it needs more cash to
recapitalise the banks.


The EU is conducting a new round of bank stress tests,
possibly with more transparency, to establish potential losses
of banks under various scenarios and their recapitalisation
needs. Results are expected to be released in June, after which
member states are supposed to take action to ensure the
recapitalisation or restructuring of vulnerable banks.

Criteria for banks passing or failing the tests have yet to
be set. EU leaders agreed that: “A high level of disclosure for
banks will be ensured, including on sovereign debt holdings.”

But the tests may not be tough enough to convince markets.
They will not include assets held in lenders’ bank books,
allowing peripheral sovereign bonds classified as held until
maturity to escape writedowns. Also, the European Banking
Authority has said bank liquidity will not be a formal part of
the tests, but analysts say liquidity is a crucial issue.

Stress tests published last July initially reassured markets
but the positive effect faded after Irish banks, which had done
well in the tests, ran into serious trouble.


Major euro zone governments have been pressing Portugal to
seriously consider taking an EU/IMF bailout, in order to address
a major source of market instability in the zone.

Since the resignation of Portugal’s prime minister on March
23 and downgrades of its debt ratings, analysts think the chance
of Lisbon being forced to ask for a bailout has risen. Logical
times for this are before bond maturities in April and June.

But Lisbon is still rejecting the idea of a bailout and EU
sources say it is unlikely Prime Minister Jose Socrates will ask
for help in the next two months — the constitutional length of
time before the next general election.

A euro zone source said in January that were Lisbon to seek
help, the aid plan could be 60-80 billion euros.


Leaders have agreed on a “Pact for the Euro” that includes
commitments to reforms to boost growth and employment and
safeguard public finances in the euro zone. A key element is
that countries will enshrine EU budget deficit and debt limits
in national law — effectively making it illegal to breach them.
The limits are 3 percent of gross domestic product for budget
deficits and 60 percent of GDP for public debt.

Countries with public debt exceeding 60 percent of GDP must
cut it annually by 1/20th of the amount above 60 percent. There
is agreement to raise retirement ages in line with life
expectancy and limit early retirement schemes.

To make economies more competitive, leaders agreed to give
particular attention to ensuring wages grow in line with
productivity, including a review of wage indexation mechanisms.

While the pact is for euro zone countries, non-euro zone
members are free to join and Bulgaria, Denmark, Latvia,
Lithuania, Poland and Romania declared they would.


The existing EU budget rules, the Stability and Growth Pact,
will have more teeth. Changes are still being debated by the
European Parliament; a final agreement involving parliament and
governments is expected to be reached in June.

Requirements to place money in interest bearing-deposits and
non-interest bearing deposits, and fines of 0.2 percent of GDP,
might be imposed on countries which do not reduce budget
deficits to reach balance, which are put into an excessive
deficit procedure (EDP), and which do not comply with
recommendations issued under the EDP.

To make disciplinary action more automatic, sanctions will be
imposed once the European Commission proposes them, unless a
majority of countries stops them. Euro zone leaders agreed that
EU finance ministers, which decide on imposing sanctions, “are
expected to, as a rule, follow the recommendations of the
Commission or explain its position in writing”.

There will also be an excessive imbalances procedure for
countries based on a scoreboard of macroeconomic criteria, to
minimise the risks of imbalances such as housing bubbles; an
annual fine of 0.1 percent of GDP will be imposed on a country
with such imbalances if it fails to address them.

(Editing by Andrew Torchia)

Q+A-What steps is euro zone taking on debt crisis?