Judgment day for Slovenia

December 12, 2013

The Slovenian government is poised to publish the results of an external audit of its banks, which will say how much cash the government must inject to keep them afloat. We’ve heard from sources that the euro zone member needs as much as 5 billion euros to recapitalize largely state-owned banks.

The central bank said on Tuesday that sufficient funds were available to an international bailout but, while the euro zone might breathe a sigh of relief, Ljubljana’s problems are far from over. A fire sale of state assets will be triggered and the banks are so embedded into the Slovene economy that deleveraging will cause great damage.

The government may raid its own cash reserves of 3.6 billion euros, hit junior bank bondholders to the tune of 500 million euros and, if necessary, tap financial markets. But all this may just be delaying the inevitable for a country that is expected to wallow in recession until 2015. Prime Minister Alenka Bratusek has called a cabinet meeting and a news conference is tentatively scheduled for 1000 GMT.

European Central Bank chief Mario Draghi testifies at the European Parliament at some length today. With inflation forecast to remain well below target for the next two years, pressure is growing to act and Draghi has said a number of options were possible, and ready to be deployed.

Most – particularly full-on QE – are unlikely. The most likely – a repeat of the splurge of cheap, long-term money thrown at banks last year – has now been saddled with a new caveat.

Draghi said last week the ECB would only sanction another “LTRO” if he was convinced banks would use it to lend into the real economy, which they didn’t last time, rather than as cheap money for a carry trade into government bonds giving a guaranteed return, which they did. Presumably the ECB is consulting with the banks or is Draghi saying a new LTRO is really quite unlikely, which is strongly counter to market expectations?

We got a pretty strong clue from chief economist Peter Praet last night. He told the FT the ECB may make euro zone banks hold capital against sovereign bonds on their books to try and stop them using cheap liquidity for carry trades.

This also has profound implications for the health test of banks due next year if government bonds were judged according to the risk they pose to a bank’s capital. Praet said that if the bank tests had the unintended consequence of impeding lending even further then the ECB would provide more cheap long-term loans.

This is complicated though. ECB vice president Constancio said yesterday that most of the weakness in bank lending was due to lack of demand from companies and households, not lack of supply. So all this could be like pushing on a piece of string.

Praet is something of a forward thinker at the ECB but if Draghi backs him up today that will be big news, as will be the central bank chief’s views on the latest banking union blueprint which looks likely to leave the onus to rescue or wind up banks squarely on national governments for several years to come.

EU negotiators also agreed yesterday that bondholders and large depositors in a failing European bank face losses from the start of 2016, two years earlier than had been planned. This is the Cyprus model of bailing out and hasn’t scared the horses yet but may yet make investors look askance at bank debt and stock.

Coincidentally, Cypriot Finance Minister Harris Georgiades  presents the first budget since the chaotic bailout this year forced it to close a major bank and launch a controversial deposit-grab in a second to qualify in 10 billion euros of emergency loans.

The Swiss National Bank is unlikely to pull any rabbits from its hat at its quarterly meeting. Our polling suggests the cap it imposed on the Swiss franc in 2011 will be left in place until 2015 or later, while interest rates – at 0.25 percent – are not expected to move up much sooner.
Separately, the Swiss government releases its growth forecasts for next year. The figures will give an indication of how well the franc cap has protected the economy from recession, but may also lessen the central bank’s justification for the policy.

Unrest in France with the dominant CGT labour union calling a strike on the railways which started last night and will run until tomorrow morning. It is protesting over reform of the structure of the SNCF railway company, which CGT and other unions say will undermine working conditions.

The UK, in contrast, seems to motoring, albeit from a low base. The British Chambers of Commerce predicted overnight that the UK economy will expand at its fastest rate in seven years in 2014 – by 2.7 percent. That’s above the 2.4 percent pencilled in by the government’s independent forecaster.

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