Worries about Spain resurface ahead of talks on EU 'firewall'

Thu, Mar 29, 2012, 01:00

EUROPEAN DIARY:The euro zone may have stabilised but further financial tests are looming

EURO ZONE finance ministers gather in Copenhagen tomorrow in an effort to finally settle divisions over the size of their “firewall” against the financial crisis. The Anglo Irish Bank debt question may feature tangentially, but there is some way to go on that front.

The talks come amid an easing of tension in sovereign bond markets, which is attributable in large part to the European Central Bank’s €1 trillion liquidity scheme for banks.

Brussels is a more tranquil place as a result, giving weary denizens of the crisis an opportunity to catch some breath. After two years of non-stop action, a certain sense of relief is palpable. But it’s not over yet, far from it. Just as prolonged wrangling over the size and combination of the two euro zone bailout funds comes to a close, worries resurface about Spain’s capacity to survive the whirlwinds of recession. The “firewall” debate has been ongoing for more than a year. While EU leaders have agreed to introduce the European Stability Mechanism (ESM) permanent bailout fund one year early in July, the fear remains that its €500 billion lending capacity is still too small. Hence the talk of combining the ESM with the €440 billion European Financial Stability Facility (EFSF) temporary fund, which was supposed stop new operations once the ESM started up.

Among the weather-beaten frontiersmen of the crisis, those who argue for an outright combination of ESM with EFSF are known as the “maximalists”.

They include senior figures in the EU institutions, many euro zone countries, world powers such as the US and global bodies like the IMF and OECD. Against them all stands Germany, which has resisted any increase in the ESM’s preordained firepower.

This is crucial. “I don’t think that the pure maximalist demands will meet with unanimous enthusiasm, put it that way.” says a senior European official. Implicit here is the clear sense that Germanic restraint will carry the day. Berlin may now be willing to accept an arrangement in which the ESM and EFSF temporarily operate side-by-side, but this is a “minimalist” kind of a compromise.

The deal won’t be done until Copenhagen. Right now, however, expectation is that the €200 billion the EFSF has already committed to Ireland, Greece and Portugal will run concurrently with the ESM for one year. The remaining €240 billion in uncommitted EFSF capacity would be frozen, but could be activated if the need ever rose. On the face of it the “firewall” would thus expand – albeit temporarily – to €700 billion. Not so fast, however.

The ESM’s entire €500 billion won’t be available until euro zone countries provide a total of €80 billion in cash by way of paid-in capital. This sum was to be paid in five equal annual instalments, starting this year. The ministers have already resolved to bring forward the second instalment to this year. To give the ESM more upfront capacity, they may decide to expedite the third and fourth instalments next year.

All of that remains to be decided. Depending on the settlement reached, however, the advertised lending capacity may be more than the true level in the here and now. Still, this is a debate which remains deeply controversial in Germany. For proof of that look no further than remarks in London yesterday from Jens Weidmann, chief of the Bundesbank and a former adviser to chancellor Angela Merkel.

“Just like the ‘Tower of Babel’, the ‘Wall of Money’ will never reach heaven,” Mr Weidmann said. “If we continue to make it higher and higher, we will, in fact, run into more worldly constraints – both financial and political ones.” This reflects concern that an overzealous increase in the firewall would lead inexorably to ever-increasing suspicion about the contingent liabilities in the public finances of countries like Germany.

A similar sense of caution is evident in relation to Dublin’s push to restructure the Anglo promissory notes, although the Government is hopeful of a concession to avert a €3 billion cash payment due on Saturday. “There is an awareness of the sensitivities around this,” the senior European official says.

Awareness alone won’t fix the problem, however. Although head of the group of euro zone finance ministers Jean-Claude Juncker says there are good reasons for easing the burden, Germany remains to be convinced.

Then there is the Spanish question. Centre-right premier Mariano Rajoy held off producing this year’s annual budget until tomorrow to increase his chances in a key regional election in Andalusia last Sunday. The gambit backfired. The left won out.

Even as Rajoy produces a new round of painful austerity measures, he and EU economics commissioner Olli Rehn are trying to beat back claims that Spain may require bailout fund aid to boost its ailing banks.

While the EU authorities would rather not go down that road, Rajoy’s politicking with his deficit targets did little to enhance his reputation in Brussels. The euro zone may be a calmer place these days, but further tests loom.