Successful Bond Sales Calm European Debt Fears

Wednesday, 26 Jan 2011 07:00 AM

 

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Successful debt sales helped maintain relative calm on European bond markets Tuesday, but top European Union officials urged governments not to procrastinate on new measures to tackle the crisis that has pummeled the continent over the past year.

Spain — the country that many analysts say could make or break the 17-country eurozone if it runs into financial trouble — auctioned 2.2 billion euros ($3 billion) in short-term debt at much lower interest rates. Meanwhile, the currency union's bailout fund effortlessly sold 5 billion euros in five-year bonds to fund its first contribution to the 67.5 billion euro rescue loan for Ireland.

But despite the good news from financial markets, EU officials and analysts warned that governments should not be tricked into thinking the current crisis is over.

"We have seen in the past that when there is no pressure there is a tendency for procrastination," Jose Manuel Barroso, the president of the EU's executive Commission, said at a conference of Brussels think tanks. "We at the Commission are doing everything, everything we can to create a sense of urgency."

The yields, or interest rates, on the longer-term debt of Portugal and Spain, the two countries viewed as the eurozone's next-weakest links, are off record highs reached just weeks ago, but still way above levels seen as recently as October, when the crisis was in its last lull. Yields not only indicate a country's funding costs, but also reflect investor concern over its ability to repay its debts.

While the sense of immediate panic appears to have left bond markets, investors have their hopes set on a "comprehensive" package of new crisis measures, including beefing up the region's bailout fund and giving it the power to buy governments bonds on the open market. But the European Commission is struggling to get support for some of its plans from big member states such as Germany, which claim there is no need for rushed measures now.

In a quest to get the currency union's financially strong members on its side, Barroso met with Dutch Prime Minister Mark Rutte Tuesday afternoon, before flying off to Berlin to have dinner with Chancellor Angela Merkel in nearby Meseberg castle. The EU's Monetary Affairs Commissioner Olli Rehn was also in Berlin Tuesday, for a meeting with parliamentarians of the German Liberal Democrats, the junior party in Merkel's coalition that has come out against an increase of the current bailout fund.

Reflecting the precarious balance on financial markets, analysts welcomed Spain's plan to make its ailing savings banks set aside more reserves — but warned that the banks' recapitalization may get expensive for the cash-strapped government.

The local savings banks, or cajas, have been at the center of concerns over Spain, which is struggling with an unemployment rate of almost 20 percent, a swollen budget deficit, and weak growth after its real estate bubble burst following the collapse of Lehman Brothers in 2008.

Analysts worry that the cajas, the prime lenders for boom-time construction projects, will face a new tide of bad loans when the real drop in property values is realized — potentially requiring expensive government bailouts like the ones that forced Ireland to ask for help from its fellow eurozone states and the International Monetary Fund.

Spanish Finance Minister Elena Salgado said Monday the banks will need about 20 billion euros to get their capital ratios to 8 percent from currently 6 percent by September. Banks that can't raise the necessary funds on the open market might have to be partially nationalized, Salgado said. To qualify for government funding, the private banks would then be forced to list on the stock market.

The aim of the restructuring was to "dissipate any doubt about the solvency of lending entities," Salgado said.

But analysts warned that the cajas might need much more money that the finance ministry estimated and that most of them would have trouble raising funds on the open market.

"The program details fall short of what markets had been expecting in terms of recapitalization costs and plan timeline," said Tullia Bucco of Milan-based UniCredit Research in a note to investors.

Barclays Capital Research said "recognition of the insufficiency of capital buffers in the system is a step in the right direction" but doubted that the weak saving banks will manage to raise the needed funds in the market. The banks may actually need euro46 billion, Barclays said.

Despite the doubts, Spain was able to sell 2.2 billion euros in debt, with the average interest rate in the 3-month bill sale dropping to 0.9 percent from 1.8 percent in the last such auction Dec. 21. The rate for 6-month bills was 1.8 percent, down from 2.6 percent last month.

Meanwhile, the European Financial Stability Facility, the eurozone's bailout fund, said its 5 billion euro bond sale was almost nine times oversubscribed, getting orders worth 44.5 billion euros from more than 500 investors. Ireland will only receive 3.3 billion euros of the 5 billion euros since a cash buffer is needed for the fund's triple-A rating.

Analysts cautioned against giving to much weight to the EFSF's successful bond sale.

"Honestly, who doubted that Europe has the money to bailout Ireland," asked Carsten Brzeski, eurozone economist at ING in Brussels. It's a potential bailout of Spain, whose economy is about as big as those of Greece, Ireland and Portugal combined, that would seriously test the bloc's capacity.

With an interest rate of 2.89 percent for its triple-A-rated bond, the EFSF is a more lucrative investment than similar bonds issued by Germany, which traded at a yield of 2.32 percent Tuesday afternoon.

The successful bond sales don't change the fundamental problems faced by struggling countries like Greece, Ireland, Portugal and Spain, which over the next year will have to pay off high debt piles at expensive interest rates amid weak growth and painful structural reforms, said Brzeski.

The International Monetary Fund on Tuesday revised downward its growth figure for Spain for 2011 by a tenth of a percentage point to 0.6 percent, which is less than half the government's prediction.

© Copyright 2014 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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