Victoria Cadman, analyst, Investec
13 February 2012
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For the euro to survive, the authorities need to come together to build a massive firewall
The turn of the year has brought a notable shift in market sentiment. Still, against a background of at best anaemic growth and slippages in fiscal plans, eurozone sovereigns need to issue large sums of debt, with the scale of such issuance a key challenge for eurozone markets this year.
We estimate that total gross eurozone sovereign bond issuance excluding bills will be around €900bn (£747bn) in 2012. Identifying what we consider to be the eight most fiscally vulnerable economies, total financing requirements between 2012 and 2015 look set to reach a massive €2.4tr. Therefore, the construction of a ’bazooka’-style backstop of the order of €2-3tr would certainly go a long way in providing a confidence boost that will settle the markets for more than a few weeks.
European authorities have been doing their best to scramble together resources, with the aim of getting close to a bazooka-sized fund. Rather than stumping up more upfront cash, the focus has been on leveraging the European Financial Stability Facility’s (EFSF) existing resources. The issue with this has been that the facility itself has struggled to raise funds, leaving little to leverage. European authorities have a trick or two left up their sleeves, such as running the permanent bailout fund (the European Stability Mechanism) and the EFSF in tandem.
If leaders can find the common ground to do this, we estimate the additional backstop provided by eurozone resources could be as much as €950bn. But it could also be quite a bit less. Unfortunately, agreeing to deliver a backstop as big as this may be a step too far for the eurozone authorities.
Fortunately, the IMF itself is in the process of raising its quotas, which would boost its potential support capacity too. The forthcoming doubling in IMF quotas and a $500bn (£315bn) boost to the IMF’s lending capacity, currently under discussion, implies the IMF’s lending capacity could soon reach $1.3tr.
European authorities still face significant challenges in boosting rescue resources, but general positive momentum in providing backstop facilities has aided market confidence in recent weeks.
Markets already seem more convinced by the scale of the firewall that is potentially available. Nevertheless, a further boost to resources may still be needed, particularly if Europe struggles to raise funds and given that the IMF will be unable to earmark all newly available firepower for Europe.
IMF member countries may be called upon to bolster their contributions once more, and this is where things could get interesting with regard to global geopolitics.
An implosion of the euro would have severe implications for global growth, but bolstering IMF resources is highly complicated and likely to involve a renegotiation of IMF voting shares. As it stands, from this autumn China will have only 6 per cent of IMF voting rights compared with the US’s 17 per cent.
Furthermore, the US does not hold a veto on such changes. In the end, the US may be forced to play ball to remain in the game. Whatever happens, such discussions may ultimately prove to be the catalyst that speeds up a shift in the balance of global power.