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Spain's Prime Minister José Luis Rodríguez Zapatero and German Chancellor Angela Merkel, at Zarzuela Palace, Madrid, Feb 03, 2011, with King Juan Carlos (l).
A summit of the leaders of 27
European Union countries will be held in Brussels today and the expansion of the
role of the Eurozone’s €440bn bailout fund will be the main issue of discussion.
Meanwhile, a paper published by a Brussels-based think-tank, proposes a
market-based approach to debt reduction, without involving default.
Both the Angela Merkel, the German chancellor and Nicholas Sarkozy, the French
president, have agreed in principle to expand the powers of the European
Financial Stability Facility (EFSF) and Merkel is reported to be pressing for
coordination on such issues as retirement ages across countries, scrapping any
links between wages and inflation and bringing corporate tax systems closer
The Financial Times says that
according to the draft conclusions sent to governments on Thursday by Herman Van
Rompuy, the EU’s president, EU leaders will agree “concrete proposals” by
next month so that the fund will have “the flexibility and financial capacity
to provide adequate support” for the euro.
The FT says the draft is vague on
Merkel's “pact for competitiveness” for the 17 Eurozone members.
The European Central Bank has
suspended its bond buying program and it's eager that the EFSF would assume
Since last May, the ECB has purchased the bonds of peripheral countries
including Ireland, with a value of €76.5bn.
Debt Reduction without Default
Daniel Gros, director of the
Brussels-based Centre for European Policy Studies and Thomas Mayer, chief
economist of Deutsche Bank, Germany's biggest, propose in a paper
Debt reduction without default (pdf), a two-step, market-based
approach to debt reduction:
Step 1. The European Financial
Stability Facility (EFSF) would offer holders of debt of the countries with
an EFSF programme (probably Greece, Ireland and Portugal = GIP) an exchange
into EFSF paper at the market price prior to their entry into an EFSF-funded
programme. The offer would be valid for 90 days. Banks would be forced in
the context of the ongoing stress tests to write down even their banking
book and thus would have an incentive to accept the offer.
Step 2. Once the EFSF had
acquired most of the GIP debt, it would assess debt sustainability country
If the market price discount at
which it acquired the bonds is enough to ensure sustainability, the EFSF would
write down the nominal value of its claims to this amount, provided the country
agrees to additional adjustment efforts (and, in some cases, asset sales).
If under a central scenario this discount is not enough to ensure
sustainability, the EFSF might agree on a lower interest rate, but with GDP
warrants to participate in the upside.
A key condition for this
approach to succeed in restoring access to private capital markets is that the
EFSF claims are not made senior to the remaining claims and the new private
bondholders. EFSF support must be comparable to an
injection of equity into the country.
The paper says while the EFSF
concentrates on the exchange of the stock of bonds, the IMF could fund the
remaining deficits in the usual way with bridge financing, until the fiscal
adjustment is completed. The ECB would of course immediately stop its
‘Securities Market Programme’, which would have lost its raison d’être.
David Milleker, chief economist at Union Investment joined CNBC after the ECB kept rates on hold and said inflation is likely to climb further and could exceed the Bank's target for most of the year: