EU Revamping Plans to Contain Debt Crisis

By James G. Neuger and Tony Czuczka - Oct 24, 2011 6:51 AM GMT+0700

European leaders ruled out tapping the European Central Bank’s balance sheet to boost the region’s rescue fund and outlined plans to aid banks, inching toward a revamped strategy to contain the Greece-fueled debt crisis.

Europe’s 13th crisis-management summit in 21 months also explored how to strengthen the International Monetary Fund’s role. The leaders excluded a forced restructuring of Greek debt, sticking with the tactic of enticing bondholders to accept losses to help restore the country’s finances.

“Work is going well on the banks, and on the fund and the possibilities of using the fund, the options are converging,” French President Nicolas Sarkozy told reporters at the Brussels summit yesterday. “On the question of Greece, things are moving along. We’re not there yet.”

Greece’s deteriorating finances have narrowed Europe’s room for maneuver in battling the contagion, which threatens to pitch the country into default, rattle the banking system, infect Spain and Italy and tip the world economy into recession.

The complete blueprint won’t come together until a summit in two days. Like yesterday, it will start with all 27 EU leaders before the 17 heads of euro economies gather on their own.

Euro Slips

The euro slipped on concern that the anti-crisis package won’t be comprehensive enough to resolve investor concern. The currency fell 0.4 percent from last week’s close to $1.3845 as of 8:41 a.m. in Tokyo.

“Bottom line: although full details are yet to be known, the proposals as they stand leave us vulnerable to disappointment that this is truly a comprehensive solution,” said Charles Diebel, head of market strategy at Lloyds Bank Corporate Markets in London.

The mayhem began in Greece in October 2009 when an unexpected cash shortfall left the new government unable to pay for its election promises. Since then, 256 billion euros of bailouts have failed to stem the tide, which rattled France this month, prompting Standard & Poor’s to warn it may lose its top credit rating.

Expressing concern over the potential impact on their nations, world leaders including President Barack Obama and Chinese Premier Wen Jiabao have stepped up calls for Europe to turn back the risk to the global economy.

Victory Claims

Europe has claimed victory over the crisis before. A plan in March was billed as a “comprehensive” strategy. A July accord on a second bailout for Greece and more powers for the rescue fund was hailed at the time as the “final package, of course,” by Luxembourg Prime Minister Jean-Claude Juncker.

Bank capital needs -- estimated at 100 billion euros by a person familiar with the deliberations -- will be met first by banks themselves, then by national governments, the European officials agreed.

Only when national efforts fail can governments tap the main rescue fund, the 440 billion-euro European Financial Stability Facility, for cash to channel to banks.

“What I can tell you is that this only will happen under strict conditions,” Dutch Prime Minister Mark Rutte said.

Germany achieved one of its main summit aims, defeating French efforts to bulk up the rescue fund by enabling it to borrow potentially limitless sums from the independent central bank. Policy makers are headed toward using the EFSF to guarantee government bond sales as a way to extend its reach. A second option is to set up an EFSF-insured fund that would seek outside investment in troubled bonds.

Expanding EFSF

“We have discussed options for increasing the firepower of the EFSF,” European Commission President Jose Barroso said. “I’m sure that progress can be confirmed on Wednesday.”

The goal is to complete the technical details within 24 hours, a European official said. The next summit will consider the two options as well as ways of getting the IMF to boost its involvement, the official told reporters. A separate statement called for “adequate” IMF resources with contributions from surplus countries such as China.

“Is it possible to get some extra funding from IMF, from BRIC countries for instance,” said Finland’s Jyrki Katainen.

Italy, with debt of 119 percent of gross domestic product, came under pressure to find more savings to be eligible for European help in fending off speculators.

Merkel on Italy

German Chancellor Angela Merkel made clear that Italy cannot count on unrestricted European support in what she called a “conversation among friends” with Italian Prime Minister Silvio Berlusconi.

“Confidence won’t result merely from a firewall,” Merkel said. “Italy has great economic strength, but Italy does also have a very high level of debt and that has to be reduced in a credible way in the years ahead.”

After a year of wrestling with the ECB over burden sharing for bondholders, Merkel was on the central bank’s side this time, sparing it from a role in financing state deficits.

What wasn’t decided is the fate of bond purchases by the Frankfurt-based ECB. The central bank has bought 165 billion euros of bonds, justifying the purchases as a way of smoothing markets and helping transmit its interest-rate decisions through the economy.

Central bankers have expressed reluctance to step up the purchases, which started with Greece, Ireland and Portugal last year and widened to Italy and Spain in August as those markets came under attack.

ECB Role

“One shouldn’t demand more from the ECB than it can achieve according to its statutes,” Austrian Chancellor Werner Faymann said.

Central bankers are also at the center of the dispute over writedowns for Greek bondholders. A reminder came on Oct. 21 when the ECB put a dissenting footnote into an assessment of Greece’s finances that envisioned writedowns as high as 60 percent.

That report, co-produced by the ECB, EU Commission and IMF, said Greece’s finances have “taken a turn for the worse” and called for bondholder losses that go beyond the 21 percent negotiated in July.

Officials are considering five scenarios to update the July agreement on losses for bondholders, people familiar with the deliberations said. The euro area is determined to avoid triggering credit-default swaps and may produce a projection for the overall writedown at the next summit, a Greek official told reporters.

Greece was tided over by an Oct. 21 decision to pay the EU’s 5.8 billion-euro share of an 8 billion-euro loan. It’s the sixth installment of a 110 billion-euro package awarded in May 2010.

EU leaders also agreed to look at “limited” changes to the bloc’s governing treaties to improve euro-area management, and designated EU President Herman Van Rompuy as the chairman of euro summits, a role he has played throughout the crisis.

“We have taken major steps to overcome the crisis,” Van Rompuy said. “See you on Wednesday.”

To contact the reporters on this story: Tony Czuczka in Brussels at aczuczka@bloomberg.net; James G. Neuger in Brussels at jneuger@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net