If one thing has turned investor sentiment in the eurozone debt crisis, it is the hope that the region’s bail-out fund will be beefed up.
Speculation is growing that eurozone leaders will over the next two months come up with plans to give the €440bn European financial stability facility more firepower.
Yet strategists and investors, used to disappointment when the rhetoric fails to match reality, are already warning them against complacency.
Elisabeth Afseth, fixed-
income strategist at Evolution Securities, says: “The EFSF must be boosted in some way, or the markets will sell off. The improvements in the markets since the start of the year are based on hopes it will be shored up.”
The first main option on the table is to increase the fund’s capacity to issue triple-A debt. In its current form, the fund can only issue €255bn in top-rated triple-A bonds because that is the amount guaranteed by countries with the top-notch rating.
While this is the most straightforward approach, it would have to be ratified by national parliaments, which could mean delays and problems as some member states, fearing the risk of moral hazard, are against committing more money.
In Germany and some other northern European countries, there is opposition to increasing the overall size of the fund above its current €440bn. Germany is already guaranteeing €120bn, or nearly 30 per cent, of the fund.
A second option is giving the EFSF powers to buy government and bank bonds of countries running into difficulties.
This is more attractive to some strategists, who say this would relieve the European Central Bank of its bond buying duties.
Buying bank bonds would also involve a more direct and efficient way of helping financial institutions on the periphery that are struggling to access the private markets or are having to pay punitive rates for loans.
Peripheral countries could also be allowed to buy back their own debt at market prices (which are trading at hefty discounts to the issue price) by using loans from the EFSF.
This would help reduce their debt to gross domestic product as they would be purchasing these bonds at below par.
But some strategists warn that such a move would be impractical as the bonds would rise in price because of the demand, meaning any reduction in debt costs might prove minimal.
Ralf Preusser, head of European rates research at BofA Merrill Lynch Global Research, adds that allowing peripheral countries to buy back their bonds would require a doubling in the size of the fund.
A third option being considered, and one of the most popular among strategists, is lowering the cost of bail-out loans, which would ease debt costs for those countries seeking loans and possibly encourage them to accept emergency support.
David Mackie, head of western European economic research at JPMorgan, says: “I think the two most important issues are the borrowing cost and using EFSF money to recapitalise directly banks.”
He stresses EFSF reforms would have to be introduced alongside tough fiscal targets to protect against moral hazard.
Like many in the market, he thinks the fund will have to be increased in size, which means seeking approval from the national parliaments, regardless of whether policymakers opt for either bond buy-backs or lower borrowing costs.
However, some warn that too much faith is being placed in the EFSF as a solution to Europe’s woes, which are more about high debt levels and a lack of competitiveness that cannot be solved by simply offering emergency loans.
Bill Blain, senior director of Newedge, the broker, says: “The EFSF is not the complete treatment. It is just a bail-out mechanism. The EFSF itself solves nothing.
“Whatever the EFSF does, it doesn’t address the fundamental crisis at the heart of the euro, which is the eurozone remains a group of disparate economies with very different productivity, fiscal and monetary outlooks, and spending requirements.”
Others say revamping the EFSF may ease short-term volatility in bond markets, but, in terms of being a conclusive solution for the eurozone crisis, it is little more than sticking plaster. Andrew Bosomworth, a portfolio manager for Pimco, one of the world’s largest bond investors, says: “While the liquidity would buy more time, it would not solve a country’s competitiveness problem.”