Euro zone hopes for funds from the Fund

April 20, 2012

Focus for the euro zone is firmly on Washington with G20 policymakers gathering ahead of the IMF spring meeting. The Fund is seeking an extra $400 billion-plus in crisis-fighting funds which, tallied with the $500 billion euro zone rescue fund about to be established, adds up to a meaningful firewall for the markets to ponder before they consider pushing Spain and Italy to the edge.

But as many sage minds are saying – U.S. Treasury Secretary Timothy Geithner among them – a firewall does not solve the root problems of the euro zone debt crisis. As our very own Alan Wheatley puts it, “It is not obvious why a stronger firewall should encourage anyone to enter a burning house”. Nonetheless, Reuters polling yesterday ascribed only a 25% and 13% chance respectively to Spain and Italy needing an international bailout.

If the IMF falls short, given the jittery mood in financial markets, that could be cue for a further sell-off. The IMF has pledges of $320 billion so far. The Chinese and British have yet to show their hands and the BRICS led by Brazil are demanding more power at the Fund before handing over extra cash. German Finance Minister Wolfgang Schaeuble told us earlier in the week that conflating those two issues was not acceptable so there is potential for a rift. The U.S. and Canada have already said they will provide no more funding. Finance ministers and central bankers from the Group of 20 advanced and emerging economies had dinner on Thursday night, ahead of a longer session on Friday.

Concerns about Spain in particular are well justified but it is not yet close to the precipice. The banks are at the heart of the country’s problems and data this week showed they are carrying the biggest burden of bad loans since 1994. They will almost certainly need more capital at some point. On the other hand, the central bank pointed out yesterday that thanks to the ECB’s three-year money offer, Spain’s banks have their funding needs covered for this year, and maybe next too. Add to that the fact that Spain has shifted half its government debt issuance for 2012 in the first third of the year and it is clear it has some time to turn around market sentiment, which soured sharply when Madrid reneged on an agreed deficit target back in March.

In the end, having lost confidence, Spain will have to do something to regain it. A strong agreement with its regions on where to cut spending might help. Ministers have met regional chiefs this week and a deal could be announced today. There is a weekly cabinet meeting today which could spell out health and education cuts, which are supposed to amount to 10 billion euros.

If the markets are onside, everything is easier. Italy showed this week that deficit targets can be loosened slightly without prompting an investor strike if they believe the direction of travel is sustainable. Spanish officials admit the communication surrounding the changed deficit target was “sub-optimal”.

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