Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Monday, 26 March 2012

Eurozone - EFSF, ESM Bazooka reloaded


Eurozone is heading for a Reservoir Dogs finish as Monti warned that Spain may reignite the European debt crisis. He in turn was warned on his labour reforms by CGIL (Italy’s biggest labour union) causing him to slow-track the reforms. Meanwhile Merkel has lowered her gun by allowing a temporary increase in the number assumed to be the size of the bailout funds. The fact that FDP (her coalition ally), who are opposed to increasing the bailout, have been hit might have something to do with it. Or it might be realisation of the TARGET2 bazooka being pointed at Germany by the periphery.

In any case, it is worth rechecking the sums in the bailout funds. The headline number is easy enough: €500bn ESM + €440bn EFSF = €940bn “Firewall”

This large number is to induce hopium confidence in the hearts of carry traders and prevent Italian and Spanish yields from reaching a point of no return. But then 31.93% of EFSF funds are guaranteed by Italy (19.18%) and Spain (12.75%) who are unlikely to contribute to their own rescue. This leaves EFSF with €299.5bn. Out of which €215bn (including the €35bn used to buy ECB SMP holdings) is pledged towards the rescue of Ireland, Portugal and Greece. Therefore, actual remaining firepower of the EFSF is €84.5bn. This makes the whole exercise about a temporary or permanent increase rather pointless.

At this juncture, the astute reader will interject and say that Italian and Spanish contributions should be taken out after the pledged amount since Italy and Spain have guaranteed that amount already. This would leave EFSF with €153bn. There appears to be merit in the argument. But Italy and Spain are hardly going to stand behind or further guarantee funds to Greece, Portugal or Ireland when they themselves are on the brink of disaster. Given the ‘joint’ nature of guarantees given by members to EFSF, Italy and Spain pulling out means others are forced to plug the gap (and then fight Italy and Spain in domestic courts). At that point unless EFSF funds are raised again, the gap will be plugged by utilising unpledged amounts. Therefore €84.5bn is a better estimate of remaining firepower.

So total “Firewall” funds = €500bn ESM + €84.5bn EFSF = €584.5bn “Firewall”

Now all that remains is to categorise this headline number into one of the following:
  1. Bazooka
  2. Heavy Machine Gun
  3. Automatic rifle
  4. .303 Bolt Action Rifle
  5. Revolver
For that, an idea on the relation between size of the economy, sovereign debt and bailout funds required will be instructive.

Ratio of total GDP of Greece, Portugal, Ireland to Eurozone GDP (nominal) = 6%
Weighted average debt/GDP ratio at the time of first bailout = 107%
Bailout funds required till date = €275bn (110bn first package + 130bn second package + 35bn ECB’s bonds taken up by EFSF) + €78bn + €85bn = €438bn
Italian GDP / Eurozone GDP = 17%
Italian debt/GDP = 120%
Spanish GDP / Eurozone GDP = 12%
Spain debt/GDP = 68%

Assuming same relation between GDP, debt and bailout funds,
Italy’s requirement = 438 * (17/6) * (120/107) = €1,392bn
Spain’s requirement = 438 * (12/6) * (68/107) = €557bn
Total = €1,949bn

IMF unwillingness to pour more money into Europe and elusive Chinese investment into peripheral debt means that the sum above will have to be borne by Europe itself. It is highly likely that official funds are “voluntarily” aided by the private sector in another demonstration of European public-private partnership.

And the correct answer to the categorisation question is none of the above. This probably isn’t even a pea-shooter.

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