Is market happy with 100bn euro bailout for Spanish banks?

Global markets corrected yesterday despite Spanish banks getting a 100 billion euro bailout deal. According to Patrick Legland, Global Head of Research at Societe Generale, this was because doubts still linger as to how Spain will kick start growth and reduce its debt levels.

In an exclusive interview to CNBC-TV18, Legland says that “the amount of 100 billion support for Spanish banks is a good step, but the main question mark for the market is will it be enough.” He further adds that markets will be very volatile going forward if EU leaders cannot deliver on growth during the European Summit later this month, if chances of a ‘Greexit’ increase and if there is uncertainty about financing of the 100 billion euro bailout. Below is an edited transcript of his interview with Latha Venkatesh and Gautam Broker. Also watch the accompanying video. Q: To what would you attribute this mild green that we are seeing in the European equity markets? A: I think this is just a technical rebound. There are still too many uncertainties about Spain, Greece and growth in Europe to have a sustainable rebound in European markets. Q: Could you take us through what let to this sharp correction from the initial euphoria that we had seen? Do you think there is a realization in the market that perhaps the state will have to bear the cost of Spain’s additional loans, and that since this is not fresh equity infusion it’s potentially negative over the longer term? A: I think unfortunately you are right. The main question mark for the market is how will it be possible to restart growth in Spain to gradually reduce the level of debt. At this stage, also there is a beginning of a very strong support for Spanish bank. We know that potentially total bailout for Spain would be 450 billion euro. It is very unlikely we will go through this level, but on the other side without any growth, it will be extremely difficult to reduce debt in Spain and in the rest of the Europe. The second point is that if we take the total amount of potential property losses for banks, it is in the region of 180 billion euro. The amount of 100 billion support for Spanish banks is a good step, but the main question mark for the market is will it be enough. Q: So how do you expect things to pan out now? Will the market continue to recede because of fears of bigger bills having to be borne and more importantly how will it go to the Greek election? A: We have three potential market drivers. One is Spain, where we wait for more details about financing of this 100 billion euro. The second is Greece, where our central scenario is that Greece will stay in the euro zone and that it will stick to the euro. There is obviously growing risk that maybe the vote will be negative and at the end of the day Greece exits euro. Third point is the European Summit which will be on June 27-28, where the market expects the European leader to take steps to support growth in Europe. Without these three, it is very likely that markets will remain very volatile. _PAGEBREAK_ Q: You and your team have actually worked out a lot of scenarios about what happens if Greece were to exit. If Syriza comes to power, do you think markets will start correcting and you could have a meltdown across markets, or do you think the market will wait by for what Syriza and the leaders have to say there before taking a call? A: I would want to reiterate that our central scenario is that Greece will remain within Euro. If we take the ultimate scenario that Greece might exit euro, it would be very negative because the Greek economy would not benefit from any competitive valuations. They have little to export and is importing a lot, which means that immediately after a Greek exit they would have an inflation of 40-50% which would be absolutely dramatic for the economy. The second point is that there is a risk of bank run in Greece which would be negative as well. Also, it would certainly raise question marks on other countries which might leave euro, which is why we think the European leader will try their best to avoid an exit of Greece from the euro zone. Q: So if you expect the risk aversion to continue, what might be the preferred asset classes over the next two months? Are you going to see further strengthening of the dollar index, does it go to 83-84 and thereabouts? A: We see that on one side dollar denominated assets are seen as a safe haven. But on the other side, the euro is still holding up relatively well. So it’s not so sure that we will see big swings in currency. The second thing, and you might be surprised by what I am saying, is relatively cheap assets are equities because they are trading not very far from net asset value, from book value. Yield on equities are very strong, but there is a question mark on whether equities might still remain relatively cheap for a while. For investors with a long term view, equity is certainly a buy in Europe. So we like corporate high yields, where we think there is some good value in Europe and in the rest of the world. We are negative on commodities, excluding on gold which should remain a safe haven for the next few months, this is our core recommendation. Q: If the New Democracy Party were to come to power or we have a favourable outcome in Greece, do you think risk assets or equities in US and Europe are set for a rally? A: Absolutely because as I said equities, particularly European equities, are cheap. But there are many uncertainties hanging around valuation. If we have positive news on Greece on one side and if we have further clarity coming from Spain, plus may be some measures to support growth, obviously equities will have a big rally. But these are three big if’s, and as you said the market is still in uncertainty. Q: There are some experts who have told us that they see the euro going down all the way to 1.15. Do you think that we will see that kind of problems as Europe grapples with how to find the money for all the banks in the sovereigns? A: Unfortunately I think that on one side US is making the best to maintain the dollar to relatively low level, which is positive for the euro. We are right now at 1.25 and euro is very clearly over valued. If we could have lower price for the euro, maybe in the range of 1.10-1.15, it would be very positive for Europe because it would bring competitiveness. But unfortunately, I am not too sure it will happen because there is a contrary argument that as Europe takes the right measures in terms of governance and financing, it will be positive for the euro and negative for the economy. So it’s kind of a Catch 22 unfortunately.