Satyajit Das: Europe does not have the funds to solve sovereign debt crisis

Midweek View: The Lisbon treaty prohibits the European Central Bank from directly buying national governments' debt
Click to follow
The Independent Online

European equity and bond markets reflect a growing belief that the eurozone and the European Central Bank (ECB) has, at last, taken the correct policy actions. But talk of the end of the crisis it is premature.

The financial resources remaining to deal with the crisis may be insufficient. The major bailout facility – the European Stability Mechanism (ESM) – has total lending capacity of €500bn (£430bn), of which €208bn is still available.

Greece, Ireland or Portugal may need further assistance. Spain and Italy may need assistance programmes. Spain has debt of €800bn (74 per cent of GDP). Italy has debt of €1.9 trillion (121 per cent of GDP). Both have significant debt maturities in the near future. Spain has principal and interest repayment obligations of €160bn in 2013 and €120bn in 2014. The Spanish government has announced a financing programme of €260bn for 2013. Italy has principal and interest repayment obligations of €350bn in 2013 and €220bn in 2014.

Additional resources may be needed to finance a deposit insurance scheme to halt capital flight from peripheral European countries. An effective deposit scheme would need to cover €1trn to €1.5trn of deposits, placing a large claim on available funds.

Europe may need bailout facilities of at least €3trn to be credible. Potential requirements exceed available resources.

The only other potential source of financial support is the ECB. It has already provided more than €1trn in term financing to banks through the LTRO (long term refinancing operation) programme alone. The ECB has purchased €210bn in sovereign bonds under the SMP (Securities Markets Programme). In July 2012, the ECB announced the OMT (outright monetary transactions ) programme, allowing purchase of unlimited quantities of sovereign bonds. But the OMT programme is conditional. ECB action is contingent on the relevant government formally requesting assistance and agreeing to comply with the conditions applicable to assistance from the ESM/EFSF (European Financial Stability Facility). Instead of avoiding market pressures, the triggering mechanism requires that financing problems of "at-risk" countries get worse before the ECB will act.

ECB purchases will be confined to short or intermediate maturities. This condition is designed to make intervention similar to traditional monetary policy. It is also designed to reduce the cost of bank loans which is driven by shorter-term interest rates.

The ECB can also nominate a cap on yield or the size of its purchases in advance of any intervention.

The OMT programme revealed significant divisions within the ECB. Jens Weidmann, the head of the German Bundesbank, opposed the measure. Other eurozone members are also known to be uncomfortable.

Article 123 of the Lisbon treaty prohibits the ECB from directly buying national governments' debt. Future legal challenges cannot be ruled out. Overcoming legal issues would require time-consuming treaty changes, support for which is not assured.

Mr Draghi's statements have been dominated by two words: "may" and "adequate". The market analyst Carl Weinberg neatly summarised this as: "A promise to do something unspecified at some yet-to-be-determined time involving yet-to-be-invented programmes and institutions, in a yet-to-be-decided way".

The OMT has not been activated to date. The ECB has gambled that the announcement that it is prepared to intervene will restore market access of peripheral borrowers and reduce the interest rate demanded by the market. The borrowing cost of weaker countries remains above sustainable levels. But the true access to market remains unclear because of the activity of banks purchasing sovereign debt which can be financed with the ECB at a profit.

Mr Draghi operatically stated that theECB was ready to do whatever it takes to preserve the euro, adding "believe me, it will be enough". Markets will undoubtedly test the ECB's resolve. As Yogi Berra knew: "In theory there is no difference between theory and practice. In practice there is."

Satyajit Das is author of 'Extreme Money' and 'Traders Guns & Money'