Why capital markets have no more reservetions about Eurozone

Eurogroup Meeting. Wolfgang Schauble, German Federal Minister for Finance, Jorg Asmoussen, Member of the Executive Board of the European Central Bank and Pierre Moscovici, French Minister of Finance, from left to right. (Eurogroup Photographic Library 08.07.2013).

Eurogroup Meeting. Wolfgang Schauble, German Federal Minister for Finance, Jorg Asmoussen, Member of the Executive Board of the European Central Bank and Pierre Moscovici, French Minister of Finance, in the foreground from left to right. (Eurogroup Photographic Library 08.07.2013).

Borrowing on international markets is not at all a straightforward activity. Things are even more complicated when it comes to long-term debt paper with maturities spanning to decades. This little theory tells a lot about Eurozone’s creditworthiness. As a matter of fact, during the last few weeks the European Financial Stability Facility (EFSF) borrowed from capital markets €8 billion by issuing bonds of 7 and 21 year maturities. EFSF is authorised by Eurozone to issue debt instruments on the market to raise funds needed to provide loans to Eurozone countries in financial difficulties. EFSF issues are backed with guarantees of up to €724bn given in common by euro area Member States. Yesterday the EFSF borrowed €986 million on a 7 year bond.

EFSF is to be replaced in a few weeks by the European Stability Mechanism (ESM) which is an intergovernmental institution inaugurated on 8 October 2012 by its shareholders, the 17 member states of Eurozone. Its mandate is also to preserve financial stability of Europe’s Economic and Monetary Union by providing financial assistance to euro area Member States in difficulty, exactly as the EFSF. The ESM will launch an inaugural long-term bond issue next month. The Mechanism is the full fiduciary of the EFSF. ESM’s long-term funding programme is scheduled to be €9bn in 2013 and €17bn in 2014. Not everybody is happy though with Eurozone’s successes.

From Russia with vengeance

It’s interesting to note that Dimitry Medvedev, currently serving as Russian Prime Minister, after been transferred by Vladimir Putin many times to and from the positions of PM and President, made yesterday a revengeful comment about this 7 year bond issued by EFSF. He said that “during those 7 years Eurozone could disappear”. Of course this is not a financial prediction but rather an off-limits personal comment.

Presumably it comes after the EU – Russia relations have gravely deteriorated lately. The EU is actively encouraging the Kiev government in its quest to strike an Association Agreement with the Union. This prospect has greatly annoyed Moscow. Russia was also surprised by the EU over the Cyprus financial crisis last June. The Eurogroup then decided to actually confiscate almost 80% of the multi-billion deposits from many wealthy Russians kept with the island’s banks.

In Eurozone they trust

Coming back to debt issues by the EFSF/ESM financial tools, the full capital market acceptance of those placements is an infallible witness that the overall creditworthiness of Eurozone is of prime rank. Given that ESM shareholders and guarantors of its debt issues are the 17 Eurozone member states, their mutual responsibility is fully recognised and accepted by investors. This is a plain acknowledgment that Eurozone has definitely overcome any risks of breaking apart. More so, now that Eurozone is guaranteeing Greece’s financial security well after 2014, while the European Central Bank, with its Outright Monetary Transactions (OMT), has reassured the capital markets that Italy and Spain will be able to continue borrowing at sustainable interest rates. OMT is an ECB programme for Eurozone state bond purchases in the secondary markets under certain conditions.

Seen from a clear perspective, the long maturity debt issues by the EFSF/ESM mechanisms are actually a kind of Eurobond issues, purporting mutual financial responsibilities to the 17 Eurozone members. In this framework the 17 Eurozone countries accept in common huge financial liabilities, albeit restricted up to a round sum of €1 trillion. However the mutual financial responsibilities of Eurozone countries are not limited to that. ECB’s OMT programme is another commonly accepted liability. Thankfully the central bank hasn’t spent yet not one euro under this heading. By the time though that the OMT programme was decided by the Governing Council of the central bank, this was not at all certain.

Actually, back in September 2012, when the OMTs were launched, there couldn’t be a reliable estimate of their potential magnitude. Consequently, the 17 countries, including Germany, which accepted this common liability didn’t have a way to know the possible cost of the programme. Still they accepted it. Again these OMTs could end up to something like mutual financial liabilities of all the 17 countries, prudent and imprudent, in deficits or surpluses, all in the same boat.

This is the real reason why today there is not the slightest reserve about the decisiveness of Eurozone to stay one piece and its 17 member states to face together whatever challenge lies ahead. They have already proved that.

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