Barroso calls on eurozone to speed up completion of EFSF legislation

EC president calls for urgent action on bailout mechanism, but analyst says it could be months before the EFSF is legally allowed to purchase government bonds on the secondary market

José Manuel Barroso, president of the European Commission (EC), has urged member states to speed up the approval of enhancements to the eurozone bailout mechanism, amid concerns contagion effects from the sovereign debt crisis are spreading to Italy and Spain.

In a letter to European heads of state on August 4, Barroso expresses "deep concern" over developments in the sovereign bond markets of Italy, Spain and other eurozone member states, noting that while plans to increase the flexibility of the European Financial Stability Facility (EFSF) were a "bold" step, they were not having the "intended effect" in markets. "Whatever the factors behind the lack of success, it is clear we are no longer managing a crisis just in the euro-area periphery," Barroso says.

To address the current contagion, Barroso called on member states to further improve the effectiveness of both the EFSF and the European Stability Mechanism, and to "accelerate" the approval procedures for the implementation of the EFSF's operational enhancements very soon. He says the changes should also not include excessive constraints in terms of either additional conditionality or collateralisation of EFSF lending. "I trust that governments and national parliaments will rapidly approve these decisions as necessary to improve the EFSF flexibility," Barroso says.

After an initial dip in bond yields following the announcement of a €109 billion ($153.8 billion) bailout package for Greece in July, yields on Italian and Spanish debt have climbed sharply, amid concerns the sovereigns will need to restructure their debt. Ten-year Spanish yields have risen 27 basis points since July 21, to 6.341% at 3pm UK time. Investors are also demanding a significant premium for Italian debt, with yields on 10-year bonds up 59bp to 6.151% on August 4.

Markets are concerned that the EFSF does not have the capacity to provide financial assistance for Italy and Spain were they unable to access markets for funding. As part of the second bailout deal for Greece, the EFSF was called to extend maturities on Greece's loans, from 7.5 years to a minimum of 15 years, and reduce the cost of loans by a percentage point to 3.5%. The bailout vehicle was also given the green light to purchase bonds in the secondary market, however, the amount of funds did not increase.

Ben May, a European economist at Capital Economics, says it could be months before the EFSF was able to purchase government bonds on the secondary market. "By then, Italian and Spanish bond yields could be much higher," May says. He says changes to the EFSF would only help Spain and Italy if they are backed up by a significant increase in the facility's "fire-power" too.

Italy and Spain will need to raise roughly €237 billion and €150 billion respectively in the second part of 2011 under current interest rates. This compares to €440 billion worth of funds at the EFSF, which is also buying loans from Greece, Ireland and Portugal. Furthermore, the EFSF will not be able to use its additional powers until after all member states ratify the agreements on a national level.

Italy bailout fears
News that Giulio Tremonti, Italy's finance minister, met with Jean Claude Juncker on August 3 fuelled further speculation that Italy may need to seek a bailout. On August 4, London-based think-tank the Centre for Economics and Business Research said Italy was "likely to default, but Spain might just avoid it".

Weak growth and political instability has added further uncertainty to Italy's commitment to address its mounting debt. Although Italy only has a fiscal deficit of 4.1% of gross domestic product (GDP), its public debt amounts to 120% of GDP. In July, the Italian government announced fiscal austerity measures to reduce the size of its deficit to below 3% of GDP by 2012 and close to zero by 2014.

However, Erik Britton, a director at London-based financial consulting firm Fathom, says even taking into account the austerity measures, Italian government debt was on an "unsustainable path". Britton told CentralBanking.com that to reach the 60% debt-to-GDP ratio required under the Stability and Growth Pact, Italy would need something in the order of a 43% haircut on its debt.

Turkey cuts rates
Concerns that the sovereign debt problems in Europe could spread to Turkey forced its central bank to cut interest rates on Thursday, from 6.25% to 5.75%, at an emergency meeting. The Central Bank of Turkey also raised the overnight interest rates from 1.5% to 5%, saying the move would "reduce the risk of a domestic recession that may be caused by the heightened problems in the global economy."

 

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