Global financial markets gave a relieved welcome to the deal agreed by eurozone leaders in Brussels designed to prevent the disintegration of the single currency. But some investors cautioned that the ultimate success or failure of the agreement, struck early yesterday morning after more than eight hours of tense negotiations, will depend on crucial details that are still to be revealed.
Stock markets across Europe rose sharply in the wake of the agreement by the heads of the 17 eurozone governments to write down the value of Greek debt by 50 per cent, recapitalise the Continent's banks and increase the resources of the European bailout fund, known as the EFSF. The euro reached a seven-week high against the dollar at one stage in trading.
The President of the European Commission, Jose Manuel Barroso, told the European Parliament in Strasbourg that Europe is "closer to resolving its financial and economic crisis and to getting back on a path of growth". Other eurozone politicians were equally upbeat. "We must not lose this chance. It's too big," the Greek Finance Minister, Evangelos Venizelos, told reporters in Athens. Christian Noyer, the head of the French central bank, said: "The major objective was really to reassure markets that the backstop would be there. Already the markets seem to agree that this is the adequate answer." And the US President, Barack Obama, said that Eurpean leaders had laid "a critical foundation" to solve the crisis.
But some prominent private sector investors said that significantly more detail was needed before policymakers could legitimately call a turning point in the emergency. Mohamed El-Erian, the CEO of Pimco, the world's largest bond fund, said: "How will the EFSF be leveraged? Where will money for the capital [for banks] come from? What will taxpayers be required to pay?"
The agreement on the 50 per cent write-down of Greek debt was struck between the eurozone and the global banking umbrella group, the Institute for International Finance (the IIF), after a decisive intervention from the German Chancellor Angela Merkel, the French Prime Minister Nicolas Sarkozy and the head of the International Monetary Fund Christine Lagarde. But the IIF confirmed yesterday that it does not speak for all the holders of Greek bonds, which means that some investors might refuse to take part in the "voluntary" write-down and could yet unravel the deal.
There was only a vague outline of how the strength of the European bailout fund will be enhanced. The official summit statement said that this would be done by offering investors insurance to hold new bonds by troubled eurozone members and "with a combination of resources from private and public financial institutions and investors, which can be arranged through Special Purpose Vehicles".
This is believed to refer to a proposal to tap funds from Chinese sovereign wealth funds. Mr Sarkozy telephoned his Chinese counterpart, Hu Jintao, yesterday to sell the plan. The French President's office released a statement saying that Mr Hu "agreed to co-operate closely to ensure the G20 can make a decisive contribution to ensure growth and global stability."
This approach will be followed up today when Klaus Regling, the chief executive officer of the EFSF, travels to China.
Another area where the summit text is unclear is over the role of the International Monetary Fund in relation to the new powers of the bailout fund. The final summit statement announced that "further enhancement of the EFSF resources can be achieved by cooperating even more closely with the IMF."
But British Government officials said they would not be prepared to countenance the IMF putting in any significant new money into the eurozone. They admitted that the IMF might need to be recapitalised due to the demands of the global financial crisis, but insisted this should not be to help the eurozone alone.
Speaking in the House of Commons after the Brussels agreement, the Chancellor, George Osborne told the Commons: "Supporting countries that cannot support themselves is what the IMF exists to do and there may well be a case for further increasing the resources of the IMF to keep pace with the size of the global economy." But he added that he was, "only prepared to see an increase in the resources that the IMF makes available to all countries. We would not be prepared to see IMF resources reserved only for use by the eurozone".
Euro rescue deal: Will it work?
Greek debt relief
What was wanted
Before this meeting eurozone states, Germany in particular, faced having to pump money indefinitely into Greece to stop Athens defaulting and sparking a global financial panic. That is why they demanded a drastic cut in Greece's €350bn debt burden. The call was for the holders of Greek sovereign bonds to accept a "haircut" of at least 50 per cent on the value of their investments.
What we got
The lobby group representing the world's top banks, the Institute of International Finance (IIF), bowed to the pressure from European leaders in Brussels and said members will accept a 50 per cent haircut. But when banks and other investors swap their existing Greek bonds for new ones, worth 50 per cent less, they will receive insurance on the new bonds underwritten by European states.
The statement from the eurozone summit says the write-downs should be agreed by the end of this year and that the exchange of Greek bonds should take place in early 2012. The IIF cannot force haircuts on its members, and does not speak for all private-sector holders of Greek bonds, but the IIF expects most of its members to agree to the write-downs.
Recapitalisation of the banks
What was wanted
The capital markets demanded that the hole in the balance sheets of European banks, estimated by the International Monetary Fund at €200bn, be filled. Investors were unwilling to lend to these banks while they feared there was a risk they might not get their money back. Analysts were calling for the sector to raise, in total, between €100bn and €250bn in new capital, in order to reassure investors.
What we got
European leaders have told the Continent's banks to raise €106bn in new funds in order to raise their capital ratios to 9 per cent. They must try to do this, first, by tapping private markets. Then they must apply to their own governments. And if they are unable to raise money in either of these ways, they will be allowed to apply to the European bailout fund, the EFSF.
The banks must outline how they plan to raise capital by the year's end to their national authorities. They must raise the money by 30 June 2012. Yet some banks have indicated they will try to reach their new capital ratios by reducing their lending. Some say the €106bn figure is out of date and that they do not need to raise so much to meet the ratio.
Boosting the bailout fund
What was wanted
A "big bazooka" to convince markets that eurozone governments would support any member state in danger of crashing out of the euro. One idea was to turn the existing European bailout fund, the €440bn EFSF, into a bank funded by the unlimited resources of the European Central Bank. The new EFSF would support member states by buying their bonds and recapitalising their banks.
What we got
The insurance idea won out. But eurozone governments will also set up another fund, a Special Purpose Vehicle. This will try to raise money from wealthy state investment funds in the developing world and lend to the EFSF so it can support member states. This means that the €440bn in the EFSF could boost its firepower up to €1.5trn.
The eurozone said it will provide more details on this scheme next month. Many questions remain about what guarantees would be offered to Asian investors for their funds, how much of the face value of the issuance of new bonds the EFSF would insure and what role the IMF will play in all this.
In numbers: Greece's debt woes
165% Greek debt (as percentage of GDP).
152% Greek debt in 2020 without 50% haircut for bondholders.
120% Greek debt in 2020 with 50% haircut for bondholders.
80% UK debt now.
Sources: Troika report, IMF Fiscal Monitor Sep 2011