EU summit: So far it's complicated - not `comprehensive'

  • At the weekend’s EU meetings, no agreement was reached on the core issues such as bank recapitalisation, the level of PSI in Greece and boosting the firepower of the euro area’s rescue funds. EU leaders expect an agreement on the ‘comprehensive package’ on Wednesday.
  • The Eurogroup endorsed the sixth tranche for Greece, which is now “pending the approval by the board of the IMF”. At the European Council meeting, growth and job creation were the main topics, but Treaty changes were also mentioned.
  • The rumour mill on the core topics continued over the weekend. The main stories are that the recapitalisation need is EUR108bn, that the haircut in the PSI in Greece could be up to 50%, and that two models to boost the EFSF are on the table.
  • As no final agreement was expected to be reached on Sunday, the limited outcome should come as no surprise to the market. Despite the disagreement on core issues, the joint statement from Merkel and Sarkozy shows that the commitment remains intact.
  • Even if we get a very ‘comprehensive package’ on Wednesday, this will not mark the end of the crisis. To end the crisis, peripherals will need to regain fiscal sustainability by structural reforms and spending cuts. This will be a lengthy process.

No `comprehensive package´ before Wednesday

At the weekend’s EU meetings, as expected no agreement was reached on the core issues such as bank recapitalisation, the level of PSI in Greece and boosting the firepower of the euro area’s rescue funds. The Eurogroup did endorse the sixth tranche for Greece, which is now “pending the approval by the board of the IMF”. At the European Council meeting, growth and job creation were the dominating themes. The council also opened up for further measures aimed at improving the surveillance which could involve Treaty changes, but the statement is very weak in its formulation. “The European Council notes the intention of the Heads of State or Government of the euro area to reflect on further strengthening of economic convergence within the euro area, on improving fiscal discipline and deepening economic union, including exploring the possibility of limited Treaty changes.”

The Eurogroup, ECOFIN and the European Council are set to meet on Wednesday ahead of the EU summit to finalise work on the recapitalisation plan.

Even if we get a very ‘comprehensive package’ on Wednesday, this will not mark the  end of the crisis. However, it could potentially bring some relief to some sovereign debt markets and limit the stress in the financial sector. To end the crisis, peripherals will need to regain fiscal sustainability by structural reforms and spending cuts. This is a process that could take years. Merkel seems to agree as she said at the press briefing last night that the next EU Summit won’t be the “last step”.

Speculation on core issues

In terms of the core issues, the rumour mill continued over the weekend.

Bank recapitalisation
This is the issue that there seems to be the most consensus on. An agreement seems close on increasing the capital ratio to 9% by the middle of next year. According to the FT, the required recapitalisation need is EUR108bn based on a stress test that marks to market sovereign bond holdings. President van Rompuy was quoted during a press briefing as saying that the leaders “will finalise details on banks on Wednesday”.

Increase firepower of EFSF
According to Sarkozy, the “choices of funds are narrowing”. However, several media reports state that differences remain on how to boost the firepower. The only really new thing on this topic is that the idea of turning the EFSF into a bank by using leverage against the ECB is now dead. This was favoured by France, but opposed by Germany and the ECB. The two remaining options are ‘the first insurance model’ and a model where more ‘new’ money is introduced. According to the FT, the other plan is to create a special fund to attract private investors. It would be set up as a special purpose vehicle where EFSF money is available to give private investors incentives to add cash by insuring them against losses. The private contribution would enable EFSF to leverage its assets. There has also been speculation about a direct contribution from the IMF. At the press conference, van Rompuy said that they were working on two models and that they might even combine these without providing any further details. The final option would be to combine the ESM and EFSF which would boost the firepower to EUR940bn. However, this would require a new round of ratification.

Greece debt sustainability and PSI (private sector haircut)
The PSI from the 21 July agreement has been reopened. Judging from the leaks reported by several sections of the media from the Troika report, it will require a PSI haircut of up to 50% or even 60% to get debt to GDP down to around 110% by 2020. (For an example of the effect of PSI, see Preview EU summit: The moment of truth). Nevertheless, Sarkozy stated last night that “Greek bondholder agreement must be voluntary”. It seems unlikely that an agreement on this matter can be reached by Wednesday as this will require negotiations with the banks.

Market reaction

Even if risk appetite improved late Friday, we do not think it was expected in the markets that a final agreement would be reached on Sunday. Hence, the limited outcome should come as no surprise to the market and, despite the disagreement on core issues, the joint statement from Merkel and Sarkozy shows that the commitment remains intact. So, the markets still have to factor in that a ‘comprehensive’ solution could be found. Markets are thus expected to be in wait-and-see mode in the coming days. If some sort of solution is presented on Wednesday, we could see a moderate positive market reaction. In the event that commitment from EU leaders to progress fades, risk sentiment could turn very negative.

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