It’s practically a foregone conclusion in some media circles Spain will soon require a bailout—with Italy possibly hot on its heels. Specifically, much has been made of the fact the combined European Stability Mechanism (ESM) and European Financial Stability Facility (EFSF) are currently insufficiently funded for complete bailouts of both countries—no doubt fueling much concern surrounding the latest chapter in the eurozone saga.
But in our view, complete bailouts for Spain and Italy are unlikely at this point as there remains strong political will to prevent that outcome. Furthermore, should yields persist at present levels, it’s more likely Spain and Italy would receive some form of partial aid from the EFSF/ESM—which would likely take the shape of having the fund(s) buy Spanish and Italian debt in the open market.
In the past, the ECB has typically taken some sort of action in order to push yields down and ease pressure at auction. In the last year or two, this has often been done through its Securities Market Program (SMP), which allowed sovereign bond purchases on the secondary market—and it seems it’s again a possibility. However, the ECB recently announced it will likely not move forward with any additional extraordinary measures (like buying Spanish and Italian bonds in the secondary market) until Spain and Italy request some form of assistance from the EFSF/ESM. This follows a big push by Spain and Italy to add the bond-buying functionality to the bailout funds at the last big eurozone summit—essentially providing an avenue for the funds to extend aid before a nation needs a full bailout.
While some could argue tapping the EFSF/ESM for bond buying would be considered a “bailout,” there are significant differences between this and the bailout programs for Greece, Ireland and Portugal. For starters, the size of the aid would be much smaller. The Greek, Portuguese and Irish bailouts from a percent of GDP perspective were quite large: Each of the three was more than 40% of the countries’ individual annual GDPs. It seems likely, should Spain and Italy receive aid in the form of bond buying, the funds used to buy Spanish and Italian debt would likely be less than 10% of their respective annual GDPs.
Furthermore, Spain and Italy would continue accessing credit markets—a significant difference vis-à-vis Greece or Portugal. In fact, the whole aim of buying Spanish and Italian debt is keeping the countries active in debt markets—Greece, Portugal and Ireland were fully bailed out because they’d already lost access to debt markets. Additionally, while tapping the EFSF/ESM for bond buying will require Spain and Italy commit to certain austerity and reform guidelines and sign a “memorandum of understanding,” the terms of their programs likely wouldn’t be as stringent as those the other PIIGS nations have had to follow—largely due to the fact Spain and Italy have already implemented their fair share of austerity and reforms and have fiscal targets set by eurozone leaders in place.
Should this scenario come to pass, it doesn’t seem likely the use of bailout funds to purchase Italian and Spanish debt would have a significant negative impact on markets as many participants are already anticipating that will occur at some point. After all, the push to add this functionality at the most recent eurozone summit raises the question, “Why push for something you don’t need or plan to use?”
And to a certain extent, there is precedent for these limited-scale bailouts. In June, Spain requested a €100 billion line of credit specifically targeting its banks. The primary reason Spain had to go to the EFSF for the funding is it would have been difficult for Spain to raise on its own, so many participants view this (despite its structure) as a form of sovereign bailout. Like the current discussion, this was preceded for months by talk. When the request came, markets didn’t react much at all. We would anticipate a similar reaction to any request for bond-buying aid.
All told, it remains the case European officials have ample tools at their disposal to address Spain’s and Italy’s situations should they become increasingly troublesome in the near term. Which, in our view, makes it pretty unlikely either nation ultimately requires a full bailout, media prognostications aside.