ESM may not be operational until next year: Lloyds Bank

European Stability Mechanism (ESM), which is Europe’s permanent rescue facility, is expected to come into force on October 8. But it is expected to be up and running only by the end of this month. Markets are expecting that, between this weekend and the month-end, Spain may make a request for a full fledged bailout.

In an interview to CNBC-TV18’s Menaka Doshi, Trevor Williams, Lloyds Bank talks about how the ESM will work in general and in the phase of a Spanish bailout request. Below is the edited transcript of the interview on CNBC-TV18. Q: The European Financial Stability Facility (EFSF) will be folded into the ESM. The ESM is expected to become operational only by month end. A: Yes. The EFSF will be folded into the ESM. The ESM will be the new mechanism for any transactions that will be conducted. So, the Troika effectively will work through the ESM to conduct open market operations. The ESM clearly won't be a borrowing vehicle. So, it will be capitalised. It will have funds available to do a certain amount of spending according to whatever deal is done. Although in theory the ESM starts next week, in practice it is going to take longer than this partly because some of the processes have still to be solidified and agreed. The key one is the disbursements of funds and the way that will work with the ECB. So, in practice, it probably is not going to start until next year. There are still a few procedural hurdles to get through before it becomes effectively operational. Q: How much fire power will the ESM have? The treaty seems to indicate between 500-700 billion euros. Will 700 billion euros be enough? A: Absolutely. I think that the way folks are thinking about is that the EFSF will have money in it. The ESM is capitalised to 500 billion euros. There is roughly something of the order of 150-200 billion euros or so in the EFSF. So, effectively it should have approaching 700 billion euros available. But, in practice, it may be less than this partly because of the structural some of the bailouts which have been done and the way that this money is being disbursed. In the short, it spent according to certain timetables and the quarterly draw downs so that some of the money in theories tied up in current deals, for example, to Portugal and to Greece. So, it is not new money that is available for a new lender. effectively the new lending is still around the 500 billion euros mark. The question is whether or not there is any ability within the ESM to borrow on top of that. _PAGEBREAK_ Q: The Ireland bailout, the two Greece bailouts and the Portugal bailout amounted to approximately 400 billion euros. Now, the ESM would have been big enough to cover such bailouts. But Spain’s economy is amongst the largest in Europe. So, if just the Spanish bank’s bailout is estimated at over 100 billion euros then how much would a full-fledged bailout require and hence will the ESM have enough firepower? A: You are right. Those are the trillion euro plus questions. If you add up the sums you have just mentioned, it effectively means roughly what I said is left in the EFSF about 200 billion or so on top of the 500 billion. If Spain were to ask for a bailout and ofcourse the 100 billion, which it had been offered, will come out of the EFSF/ESM. So, it in a sense is not new money that has been put into these. It will come out of existing arrangements which have been made. So, the question is therefore if Spain asks for additional money on top of the 100 billion, which has already been agreed in theory, then how much will it ask for? Remember, whatever it asks for will have to be repaid. It is going to be added to Spanish government debt. So, to that extent, they will be extremely wary about asking for too much because it could push their debt to GDP ratio, which is dangerously close to 100 percent already, above 100 percent of GDP. How much would that be? I think we are looking at roughly something above 100-250 billion euros, in my view, the top amount, 250 billion euros maximum. If it asks for any money, I think they are still very reluctant to do so, we all think that they need to ask for more, given the pace of growth in the economy and the increasing amounts of budget deficit cuts. That effectively means that the debt to GDP ratio is higher. Therefore, in order to keep their spending programmes manageable, they need new money. The question is how much do they need? We are not yet sure about that. But I think roughly speaking 200 billion or so. For complete interview, watch the accompanying videos.