The issue is not the EU readiness to act, but Portuguese
willingness to raise their hands for the money. Prime Minster Jose Socrates,
reluctant to relive the Portuguese "IMF stigma" of the mid-1970s, as
he is constantly reminded by the press, has watched the political hammering of
his Irish colleague Prime Minster
Brian Cowen, after accepting the EU/IMF package, with tremendous alarm. And
indeed, Portuguese opposition leader Pedro Coelho has already threatened that
he will ride a bailout straight to bringing down Socrates' government.
Last week's 1 billion Euro private placement of 2.5 year
notes was meant to reinforce Portugal's ability to tap markets. But while the
European Central Bank (ECB) has stepped in to help stem the pressure and bought
Portuguese paper, EU officials are not about to allow Portuguese intransigence
and domestic political considerations to jeopardize Spain - and the rest of the
euro. Alarmed at the spiraling turn of events, the ECB has stepped in and
intervened aggressively in frozen European peripheral bond markets, both before
and after the Portuguese bond issuance, engineering a "successful" auction.
Riding the wave of "success," Bank of Portugal Gov. Costa has now
proudly proclaimed the results a stamp of market confidence in Portugal, while
Finance Minister dos Santos continues to maintain that Portugal needs no
For all the brave talk, however, news agencies have since
then also confirmed Portugal's close call, reporting on the EU cobbling
together a package for Portugal estimated to range from 60 to 100 billion euros.
This allows Socrates to continue to try and deliver on his austerity promises
without fear of immediate political death. This also gives EU members
additional time to flesh out the necessary work needed on strengthening the
broader EFSF support package to be in place when the day of reckoning comes for
Portugal. So whether Socrates likes it or not, the EU will press hard to have a
package for Portugal ready, as EU officials are already looking beyond Portugal
to protecting Spain, who they feel have a much better chance of success.
What is likely to happen from here on? On the "expansion"
of the EFSF facility size, the EU's focus will be on effecting what is
carefully phrased as an "expanded capacity" and "reinforced
lending capacity" for the EFSF, meaning the likelihood of no increase in
the 440 billion Euro EFSF headline number, but rather a reworking of the
facility to make more of the already pledged 440 available to be put to use.
The argument is that sovereigns already agreed to a 440
billion euro commitment, but due to technical factors in trying to keep an AAA
rating, the effective amount ended up lower than envisioned. EU member states
will thus need to dramatically increase their guarantee amount in order not
just to increase the disbursable amount of the 440 billion euro pledge from its
currently estimated 255 billion euro effective limit, but in order to also
allow for a release of this "penalty" cash buffer without threatening
the EFSF's AAA rating. In the big picture, what all this does of course is
transfer some more of the peripheral credit risk onto the northern EU
countries. To the extent markets feel that European core countries can afford
to lend, or pledge, money in larger amounts and at lower (and thus riskier)
rates to their needier neighbors.
The reality, however, is that to make the full 440
available - and, critically maintain the AAA rating - EU sovereigns will have
to extend greater guarantees to the EFSF. To meet such long-term funding needs,
there are proposals under discussion. One proposal is to continue to charge
borrowers a penalty rate, and keep that as a credit buffer, and as a moral
hazard disincentive. After all, why should Ireland get money at the same rates
as Germany? But the EFSF would then refund some of the "bad credit
penalty" back to borrowers as they adhere to their fiscal plans - and their
credit standings improve. It is a workable way to ease funding costs (and
reward good behavior) over time, and help the peripherals EU countries with
their debt load.
One of the other suggestions has been to expand the scope
of the EFSF to provide liquidity assistance to sovereigns facing tight market
conditions, before getting to the stage of outright loans and bailouts. There
are commission studies proposing the EFSF issue bonds jointly with some
sovereigns on a selective basis, effectively guaranteeing if they were to face
an inordinate, and in the EU's eyes unjustifiable, amount of pressure in the
private funding markets. Whatever formulations are being thrashed out, the euro
zone is not out of the woods yet...
— Professor Mohamed A. Ramady is a former banker and
currently visiting associate professor at King Fahd University of Petroleum and