The framework commitments agreed at the euro area heads of state summit represent a “positive step” towards supporting financial stability in the eurozone, according to Fitch, although their effectiveness will depend on greater clarity on the details of the various initiatives announced as well as full and timely implementation.
The nature of the heads of state summit and the political and technical complexity of the issues at hand inevitably meant that a detailed set of proposals was unlikely to emerge. However, Fitch believes the main elements of the announced policy measures appropriately target the key causes of the recent intensification of the euro area crisis and the agency views the broad framework agreement on key principles as a positive outcome of the summit.
The agreement to materially increase the size of the European Financial Stability Facility’s (EFSF) lending capacity to around €1 trillion is a critical first step to enhance market confidence in the ability of policy-makers to limit the risk of contagion spreading to the core euro area countries. More detail is needed to assess the viability of the two options being considered (providing credit enhancements to sovereign bonds and/or setting up one or more special purpose vehicles to finance its operations) particularly with regards to their structure, financing sources and implementation.
Given this level of uncertainty and until the viability of these options can be assessed, Fitch views as critical the role of the European Central Bank (ECB) in continuing to intervene in the secondary market for euro area sovereign bonds, and ultimately to be ready to act as a lender of last resort to solvent but illiquid sovereigns issuers. However, overall Fitch views positively the evidence that the euro area Member States (EAMS) have reached agreement on the need for an enhanced support mechanism.
The provisional agreement on private sector involvement (PSI) for Greece is a necessary step to put the Greek sovereign’s public finances on a more sustainable footing, notwithstanding that – if accepted – the 50% nominal haircut on the proposed bond exchange would be viewed by the agency as a default event under its Distressed Debt Exchange criteria. However, Fitch recognises the significant challenges that the Greek sovereign will continue to face following the proposed debt exchange, against a backdrop of anaemic growth, austerity fatigue – possibly reducing the capacity to implement tough but necessary structural reforms – and continuing high debt levels, with government debt to GDP remaining well over 100% even in a positive scenario. Fitch also views with some caution the apparent commitment to increase the Greek privatisation programme by an additional €15bn, given the already ambitious nature of the existing €50bn programme.
Fitch welcomes the commitment to raise the core Tier 1 capital ratio of EU banks to 9% by June 2012, which the European Banking Authority (EBA) estimates would require increased capital of €106bn. This is an important step towards enhancing confidence in the euro area financial system. Plans to ‘urgently explore’ the options for providing state guarantees for term funding for banks could also support market confidence while helping to prevent excessive de-leveraging by banks trying to increase their capital ratios. As with the EFSF proposals, more detail will be required to undertake a comprehensive analysis of the implications of this initiative.
In addition to the main elements of the announced policy measures outlined above, Fitch views positively the further commitments to fiscal discipline and structural reform by euro area sovereigns under financing pressures as well as measures to strengthen economic discipline, governance and co-ordination, given that such commitments appropriately target some of the key causes of the euro area crisis.
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