Bernard Delbecque: Saving the euro requires restoring Spain's competitiveness
03 August 2012
This column argues that sovereign bond purchases might not be sufficient to reassure investors. A credible solution will also require a coordinated strategy to address Spain's competitiveness problem.
The most urgent challenge is to find a more credible way of reducing the spreads on the Spanish bonds. The eurozone's current plan is insufficient; allowing the existing rescue funds (EFSF and ESM) to buy bonds on the open market will buy time but will not fix the problem. These funds just do not have enough financial firepower to make a long term defence credible.
The basic problem is the existence of two equilibriums.
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The good equilibrium is where trust is high, so interest rates and low and the current stock of debt is sustainable – a fact that underpins the trust.
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The bad equilibrium where trust is low, interest rates are high and the current stock of debt looks unsustainable – thus justifying the lack of trust in governments’ ability to service the debt without restructuring.
With trillions of euros invested in eurozone government bonds, even small shifts in the likelihood of the good versus the bad equilibrium can product massive sell-offs. What is needed is progress towards some form of eurobond and/or a stronger commitment to help Spain to return to a good “low-rates/solvent” equilibrium.
Several proposals have been developed:
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Proposal 1: Convince the ECB to cap spreads of government bonds. The ECB would intervene as a lender of last resort in the sovereign bond markets.
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Proposal 2: Mandate the EFSF/ESM to commit to purchasing new debt issued by Spain as soon as market interest rates reach a predefined level. To be credible, this option should require an increase of the EFSF/ESM resources, either directly or by granting it a banking license so it could borrow from the ECB.
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Proposal 3: Agree on an adjustment programme with Spain to provide the funding to refinance its debt and cover its deficit. This option would also require an increase in the ESM resources to ensure that the ESM could help Italy as well if needed.
The situation and the way forward suggested in this column can be summarised as follows:
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An unconditional commitment of the ECB/ESM to stabilise Spanish bond yields appears unrealistic today given the critical importance of ensuring that Spain continues with responsible fiscal policy and structural reforms. Hence, a certain level of conditionality is required in exchange for financial support.
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To restore confidence, Spain will need to implement a programme that includes credible commitments to rebuild economic growth and lower unemployment. This requires, in particular, addressing Spain’s competitiveness problem with the support of the ECB. Without this, doubts about the success of the programme and the future of the euro would resurface quickly.
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