3 Problems With The EU Summit Solution That Can Hurt The Euro
Written on July 24, 2011 by Julia Woodard
Following the EU Summit last week, we had a surge in the Euro from euphoria. Several of the steps taken look to be promising, but the agreement will not act as a panacea, and has several problems that need to be dealt with.
If not, then the steps taken can still bring the European financial system stress, especially if Spain or Italy comes under pressure the way we saw in July.
Here are 3 things that could go wrong with the current proposals and which would cause the EUR to fall as a result.
1. Certain Changes to EFSF will need to be Ratified by Parliaments
One of the tools that was most promising, and that markets called for in the Summit was to give the EFSF (European Financial Stability Facility) the power to buy periphery bonds in the secondary market. Currently the EFSF can only buy bonds in primary market – during auctions – but that doesn’t help when periphery bonds are being sold off as Italian and Spanish bonds were in the first half of July.
Such a change to the EFSF will require that all 27 countries of the EU ratify it, which means their Parliaments have to pass it. In an country like Finland where elections have put in a Parliament that is very anti-bailout may have trouble passing such a change. Any bumps along the road in this ratification process will give the EUR fits, and can be a major hold up.
2. Will the EFSF be Topped Off or Does it Risk Running Out of Ammo?
The EFSF, in addition to being able to buy bonds on the secondary market, will also be able to recapitalize troubled banks as well as provide precautionary lines of credit to countries (with sounder fundamentals) which come under speculative attack. While the EFSF’s flexibility has been increased in this way – in effect turning the EFSF from a single shot rifle to a gatling gun, the clip in the gun – or the money pledged to the EFSF – still remains the same.
The EFSF was expanded to be able to lend the full €440 billion euros, but even with that adjustment which was made about a month ago, it begs the question if there is enough funds there to stave off a crisis in a bigger country such as Spain or Italy.
3. Germany’s Constitutional Ban on Fiscal Transfers
Even with the debt swap and buyback options as part of the deal, the EFSF would have to provide new loans for around€33 billion in the coming 3 years to close Greece’s funding gap. With the 10-year grace period on new loans to Greece also in the deal, the EFSF will be making the interest and principal payments on those loans. Will European states provide liquidity to the EFSF to make those payments? If that is the case then it would likely be challenged in the German Constitutional Court as there is a constitutional bank in Germany which forbids fiscal transfers to other states. We may be beyond that point now, but it is likely to be a sticking point as the question of funding the EFSF becomes a larger issue.
Each of these developments, as they come up, can hurt the EUR and bring increased scrutiny to the deal agreed to on July 21st. It’s still early in the process and more info needs to come out regarding the intricacies involved in actually accomplishing the goals agreed to at the Summit.
Till then, here’s just 3 of the problems facing EU leaders.
Nick Nasad Chief Market Analyst FXTimes
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