Spain delaying bailout due to upcoming elections: Ashmore

Jerome Paul Booth of Ashmore Investment, says that the German Constitutional Court decision is very important as it removes a possible barrier for the implementation of the program of trying to aid the peripheral European countries. The court, however, has imposed a limit on the amount of exposure that can be taken.

Below is the edited transcript of the interview. Q: What is your view on yesterday's German Parliament verdict? Do you think a major overhang is now out of the way?
A: The German Constitutional Court decision is very important as it removes a possible barrier for the implementation of the program of trying to aid the peripheral European countries. The court, has however, imposed a limit on the amount of exposure that can be taken. But this isn't important in itself because ECB's president Draghi has out layed a proposal whereby the ECB will buy bonds up to three years of countries that have signed up to the ESM program. It doesn't in itself solve the difficult issues of having countries taking pretty tough decisions on fiscal and structural reforms and having more importantly credibility return to the markets. Q: Given that there is very little conditionality attached to the clearance, which came out from the Germany Constitutional Court yesterday. Do you then think that Germany has eased its stance on bailouts of peripheral countries as a whole?
A: It is not straightforward. The conditionality attached to any possible bailout for countries like Spain and Italy which haven't yet applied are unknown. For Spain, there has been many structural reforms and austerity, that they won't be too onerous. The issue of Greece is very different. Greece is non-compliant with its existing program and there may be sparks yet in Greece. Q: Recent statements from Spain are suggesting that they may now not go ahead and ask for bailout at least in the near-term because yields looked to be stabilising. Do you think the pain for Spain is now over or there could be some more pain in the near-future?
A: In Spain precisely, the yields have come down at the short end due to a possibility that Spain may seek a bailout. And if Spain does a turns around and don't seek a bailout then the yields can go back up again. Due to local elections in October, Spain is delaying the seeking of bailout.
Draghi said that the ECB should not be blamed for the break up of the eurozone. The ECB is not going to be the catalyst for that. The ball is firmly back in government's court to get their act together with credibility as a key.
In Europe we are in a situation where politicians for many years had to persuade markets of their credit worthiness. The so called risks-free markets, which causes a complete misnomer, is signaling that many investors don't think about sovereign risks.
So, on one hand investors are starting to perceive sovereign risks, and as they do that in increasing numbers, this makes the task harder and harder for policy makers to get ahead and create confidence.
Meanwhile, the policy makers are dragging their feet because they themselves don't understand that the game has changed and they are still grappling with this reality. So, Spain is a good example where political reaction to do things except at the last moment is still a dominant feature unfortunately. Q: ECB will operationalize the bond buying program only after a formal bailout request, could that be off the table too in the near-term for Europe?
A: The ECB has made it clear that they are ready to buy the bonds. What happens next will depend on the governments. So, if Spain government comes to ESM, they can get an agreement. There will be conditionality attached that will en-trigger the ECB to buy their bonds. What happens if that isn't sufficient to rebuild private sector credibility. If that is the case then we could get a situation where ECB will buy enormous quantities of government bonds and they will sterilize. When a central bank intervenes, it effectively prints money.
And that money goes into the economy and creates inflation. In the process of sterilization, the central banks issue their own debt and brings the money back in and they don't have to print it. That is what the ECB is proposing. The ECB is massively expanding its balance sheet on both sides and this is maybe not necessary if credibility is returned.
They just have to promise to do it necessary and don't have to do it. But if they actually have to do it, you could, in a couple of years get a situation, where there is huge, absolutely enormous, trillions of liabilities and there are possibilities, there are scenarios where ECB has trouble rolling their own debt over. And then they are in the territory of unsterilized intervention and that raises the prospects of inflation. And so there are related worries.
What happens if Spain goes into a conditionality program and the ECB start buying the bonds and then they are out of conditionality. They miss targets as Greece as Greece has done. Does ECB actually stop buying? Does is actually sell the existing bonds of Spain that it has bought? If it does, that would precipitate arguably a massive crisis very fast.
On the other hand, if it continues buying, then that wrecks the credibility of the program. So there are some real issues in line. Unless the governments really go to the bailout funds and then keep the conditionality. And that has not been the experienced with Greece and so there are certainly big risks ahead still.