On EFSF intervention in primary debt markets, Angela Merkel noted "It is in fact similar to giving a loan. Whether one buys the bond issued by the government in question or gives it a loan, the difference is in effect of no matter". We would tend to agree, and in our opinion, the sovereign debt crisis is not over yet. Two key conclusions:
Well done on speed! Not only did the leaders agree a Pact for Competitiveness (now termed the Pact for the Euro), agreement was also reached in principle to (1) increase the effective lending capacity of the EFSF to €440 billion, offer it greater flexibility and lower lending costs, and (2) specifically, to lower to the cost of loans to Greece by 100 basis points and to extend maturity to 7.5 years.
In addition, the lending capacity of the ESM was confirmed at €500 billion. Governments also pledged to put in place plans to deal with any bank vulnerabilities identified during the stress tests, and agreed to explore a financial transactions tax.
The main disappointment was the failure to reach agreement with Ireland. Details will now be ironed out ahead of the March 24/25 Summit. Note that after the Summit the final agreement will still need to be ratified by national parliaments.
Yet in our opinion, the initiative could still disappoint as it (1) comes with the same conditionality under a macro-economic adjustment process and thus cannot be used to take pre-emptive unconditional action, (2) while it may help to lower yields in primary markets, it is unlikely to aid secondary markets much and investors may demand a premium as a result, and (3) private creditors' claims will be subordinate to those of the ESM.
As such, private creditors may worry they are implicitly buying subordinate debt.
The new measures primarily address funding, but still do little to address the fundamental issue of solvency. Expect more volatility ahead as the debt crisis is unlikely to be over yet.
The authors are Patrick Legland, head of global research and Michala Marcussen, global head of economics, Societe Generale