Spanish sovereign funding programme would exhaust ESM
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Spanish sovereign funding programme would exhaust ESM

Market players fear the the eurozone firewall has effectively just €1 billion of firepower after Spain taps emergency funds, triggering a debate about how policymakers can beef up crisis resolution frameworks.

All the talk around the Institute of International Finance (IIF) spring meeting in Copenhagen is of whether or not Spain will need external financial assistance if it is to raise the money to recapitalize its savings banks, support regions cut off from raising funds in their own right, and cope with the fiscal burden of low growth and high and rising unemployment that is bringing further stress to the assets of its banking system.

“Just looking at the first four months of this year, Spain looks in danger of over-shooting a deficit that last year turned out to be 8.9% of GDP,” IIF chief economist Philip Suttle points out.

While Spanish bond yields have fallen this week, the country’s problem is not so much funding at just over 6%, but rather doing so against a background of zero nominal growth.

Jeffrey Anderson, director of the European department of the IIF, suggests the country’s annual deficit for 2012 will come in somewhere between 6% and 7% of GDP, so higher than the 5.8% target that prime minister Mariano Rajoy unilaterally presented to the European Union in March in place of the 4.4% previously agreed as part of the austerity pact.

Anderson says: “Spain could be in recession next year as well, which would be year five of the downturn in Spain and it is hard to say that the pain has been fully felt yet in real-estate prices.”

Some analysts have sought to apply Irish-style loss rates to loans made by Spanish banks to the commercial real-estate and construction sectors, and guessed at likely system-wide losses of €50-€60 billion at the savings banks.

However, until the independent auditors appointed by the Spanish government report in full, it is impossible to know how big the losses will be and whether they will come at banks with enough capital and earnings to cope or not.

And while €60 billion does not sound like such a large number, funding it might prove tricky – what with the economy contracting while on track for an annual deficit of 6% to 7% of GDP, at a time when foreign investors are not inclined to lend to Spain.

According to Hung Tran, deputy managing director at the IIF, substantial European funds have been made available to Spain: €317 billion of repo finance from the European Central Bank (ECB) to its banks, on top of €46 billion of government bond purchases under the Securities Markets Programme (SMP) and then €285 billion of Target2 deficits.

Anderson says: “These funds have off-set the loss of financing from non-Spanish investors. For now, Spain retains access to Spanish investors, albeit many of them are backed by the ECB.”

That’s why the provision of European funds to recapitalize the banks, in a way that would de-link bank risk and sovereign risk, looks like it could help Spain turn the corner, and why the assumption among bankers at the IIF meeting is that all the posturing now is negotiation over the inevitable conditions attached to European financing of a Spanish savings bank recapitalization.

It’s not appealing for Spain or its European partners until you look at what might follow without it.

Tran raises the issue of what happens if that support is not forthcoming and Spain does find itself priced out of private market access. The European Stability Mechanism (ESM),which becomes fully operational next month, might then step in with a programme that some market analysts suggest would have to be €350 billion.

That would be barely manageable. The oft-stated size of the ESM, usually set at €500 billion amid discussion that it should be doubled, is simply wrong, Tran points out.

In fact, the ESM won’t have €500 billion of lending capacity available until early 2014. Its paid-in capital is just €16 billion, making its maximum lending capacity just €107 billion in its first months of operation from July to October this year. That will increase to €213 billion from November 2012 to June 2013 and only step up in increments from there eventually to €500 billion.

In the first few months, the ESM can be supplemented from the remaining European Financial Stability Facility funds of €248 billion, which could be available until June 2013. But the ESM won’t have more than €351 billion available before November 2012.

So, if Spain suddenly needs €350 billion, that would leave the eurozone firewall with just €1 billion to fight contagion everywhere else. European policymakers don’t have the leeway for any more missteps.

And while all the drama unfolds around Spain and peripheral Europe, the danger increases that ineffective, unconventional policy measures taken to alleviate the crisis are building another bubble somewhere else – in the shrinking number of supposedly truly risk-free assets remaining.

As Suttle points out: “When you want to buy a two-year Swiss note and have to pay the Swiss government 50 basis points for the privilege of lending it money, that’s quite a turnaround.”

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