Unlimited bond-buying by ECB to face opposition: Ashmore

The global markets will keenly watch the European Central Bank meeting on September 6. There are some leaked reports that say Mario Draghi will announce unlimited purchases of bonds upto three years from European sovereigns

In an interview to CNBC-TV18, Jerome Paul Booth of Ashmore Investment says unlimited bond-buying by the ECB will face opposition.

Also read: Draghi to deliver bond plan at crunch ECB meeting

Below is the edited transcript of his interview with CNBC-TV18's Udayan Mukherjee.

Q: What are you going in terms of expectations from Mario Draghi today?

A: There has been this leak that Draghi will announce unlimited purchases of bonds upto three years from European sovereigns, conditional still on being in one of the conditionality package from the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM).This is a very positive development, but there are possibilities for objection.

We have the Constitutional Court in Germany ruling next week on the constitutionality of the ESM. So, we expect this not to be a problem. The issue there is whether the ESM is a burden to the German taxpayers. There is also the issue of whether the ECB is acting within its mandate. It is not allowed to finance governments. And we are now looking at purchase of bonds upto 3 years. Is that financing governments? We can say that this is not government financing. I think the point here is politics.

ECB is determined not to go down in history as the institution that caused the failure of the Euro zone. I think we are going to see the measures necessary to save the Euro.

The logic of what Draghi is doing is that there are premiums being paid or having to be paid by countries because of the risk of break-up. He sees that as unacceptable and his intervention is to reduce that.

The problems associated with this intervention, which is a very positive thing, are that what happens if a country that is compliant with the conditionality of the ESM then becomes non-compliant. The indication is that the ECB will consider then selling the bonds from that country. Is that credible? That is another question. The reality is faced with the possibility of causing a break-up of Euro, we wouldn't expect that conditionality to be captive. That is a credibility issue.

Secondly, what happens if this sterilised intervention becomes difficult to continue? Sterilised intervention is where the purchase of bonds by the ECB, which basically is a printing of money, that money goes into European economy, which is inflationary, that money is then soaked up through the issuance of debt by the ECB. There is potentially being very short-term paper.

There is an issue if the balance sheet of the ECB gets very large, say 5 trillion euros, we may have quite a huge schedule of rollovers in this very short dated paper. What happens if there is a problem and not all of this can be rolled over? Then you enter a territory of unsterilised intervention. And unsterilised intervention can lead to inflation. We are talking potentially of a very big scale.

So, this is a dangerous course of action in some senses, but it is, in my opinion, the right course. Absolutely crucial will be the conditions and credibility. In a way, the ECB has really just kicked the football back to political authority. It really is upto the governments of Spain, starting with Spain, to get into an ESM agreement and to have that conditionality attached.

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Q: For a lot of people the bigger event is next week, not today, September 12, when the German court meets to ratify the ESM. Do you think there are risks that the Germans might not go ahead with that plan? How would markets take that?

A: The question is two-fold. First of all, will the German Constitutional Court say that the ESM is constitutional? I am not a German lawyer. I do not know.

Second, if they rule against this, and given the implicit backing for the ESM by Merkel, what is the real bargaining power? I would expect the ECB to return around and say, 'actually our job at the ECB is to ensure the continuation of the Euro and this is what it will cause and that is our job. It is your job to work out how you will deal with fiscal issues and that is your problem.' Therefore, the ECB will go ahead. It then has to find a different source of conditionality, but that is another problem. There is still the ESEF, we have the IMF perhaps as a source of conditionality instead.

I think the German Constitutional Court decision, apart from being likely, we expect to go the right way. It is difficult to say how this would actually stop the ECB or the larger political trend towards resolving this problem.

Q: How are you reading the recent data points from China because that is fast emerging as a bigger problem for global growth, according to a lot of economists?

A: I think China is successfully embarking on a transition of its economy more to a domestic demand-led model of growth. There is some slowdown involved in that. They have lots of policy tools to cope with that. The slowdown in commodities, which is marginal, is temporary. People have really over-reacted to China.

First of all, China is not the only country in the world and it is not the only emerging market. There are other countries with other cycles. China is large, but it also has the four range of policy tools and a very competent track record in terms of managing external shocks. But also we do have clear signs of pick up. It does look like we are seeing a successful rebound in China as in other EMs. We are expecting strong growth between now and the end of the year.

Q: Where does this leave the global risk-on rally in your eyes?

A: I dislike the term risk-on, risk-off. I dislike the terminology risk assets. I would say that we have got a very clear cyclical pattern here. Every year we have seen a sell-off and a recovery. If you follow that logic then we are going to recover. The data is very clear that we have a rebound in growth. We are likely to see more capital going into higher spread better returning asset classes. So, I would agree with that.

But each time this has happened on an annual basis, we have got a little more complacent about the big macro risk. This time, the volatility of the markets hasn't peaked as much as it did last year.

We should still be on our guard for much more substantial structural shift. The reason for holding a lot of the EM currency or equities, money market or sovereign bonds or corporate bonds denominated in local currencies is not just for the return. It is the best insurance policy against major disruption, major weakness in what I call HIDCC (Heavily Indebted Developed Country Currency).

We have a reduction of our risk in Europe what we don't have is a reduction of significant change in investor behaviour and significant disruption to currency market. So, at the moment, the central banks including most importantly EM central banks are massively stabilising influence. But at some point there is a need to reduce the holdings of the western currencies.

How does that come about? Hopefully, in a gradual way. That could be more of a panic. Just as we say in 1971, when the dollar basically crashed against the gold and USD 35 per ounce in 1971 to a peak of a USD 195 per ounce in 1974, a major devaluation. That risk is still there. But it is not going to be driven by the attitudes of regular poor fellow investors. The central banks are crucial because they are the really big holders outside the United States of US treasures.