Last week, EU leaders agreed to create a permanent debt crisis resolution system in 2013 when the current rescue fund expires. It will be known as the European Stability Mechanism (ESM). However, there was no agreement on whether to top up the current rescue fund and no debate on whether the eurozone should issue Eurobonds to shore up the single currency. EU president Herman Van Rompuy merely said the EU was “ready to do whatever is required”.
The Spanish ten-year bond yield has risen to its highest level this year. Meanwhile, credit ratings agency Moody’s has threatened to downgrade Portugal again. The euro has fallen to a record low against the Swiss franc. It got a boost early this week, however, as China signalled that it would continue to allocate a large portion of its foreign exchange reserves to European sovereign debt.
What the commentators said…
The “typically vague” EU statement hardly addresses investors’ concerns, said Capital Economics. We don’t know how the ESM will work and to what extent private bondholders are going to have to share the burden of a default. In any case, the discussion of the post-2013 set-up was “window-dressing”, added Carsten Brzeski of ING. “European leaders failed to address…debt sustainability and possible insolvency problems” before 2013.
With no “credible backstop to prevent further contagion”, as RBS’s Jacques Cailloux puts it, the pressure on Spain is growing. As yields keep rising, it becomes harder to raise money at a reasonable price. That fuels further fears over its solvency and thus pushes yields even higher. Figures from Moody’s suggest that Spain could have to raise, or refinance, at least e290bn, or 27% of GDP, next year, said Robert Peston on bbc.co.uk. That won’t be easy as “investors’ appetite for eurozone debt isn’t what it was”. In 2011, the financial credibility of Spain – and by extension the eurozone as a whole – will undergo its “toughest test”.
As for Portugal, Ireland and Greece, “all claim to be solvent on the basis of unrealistic assumptions about future economic growth”, said Wolfgang Munchau in the FT. That in turn makes it more likely that these countries’ electorates will lose patience with austerity packages. The European Central Bank, meanwhile, is reluctant to step up its bond-buying programme to keep yields down as it thinks the onus is on governments to resolve this mess. “It is like tidying up your children’s bedrooms,” said Morgan Stanley’s Elga Barsch. “If you always do it, they never do it.” Perhaps they’ll get round to it in the New Year.