Europe’s leaders press for new debt crisis package

Europe’s leaders want to launch a new debt crisis package so their embattled governments aren’t “at the mercy” of the markets.

The proposal comes amid some desperately needed positive signs from the euro zone countries: Portugal’s bond sale Wednesday went better than expected, German statistics showed the economy expanded at a record pace, and Belgium revealed a lower-than-forecast deficit.

European Union policy makers fear the good news won’t last, as has oft been the case in the unfolding and expanding debt crisis. They’re considering a range of options to prevent the crisis from erupting in force again, ranging from boosting the size of the €440-billion ($570-billion) bailout fund, which was tapped to rescue Ireland, to using the fund to buy sovereign debt in the hopes of knocking down crippling bond yields.

No details were available on Wednesday, though the EU made it abundantly clear that the crisis fix-it measures taken in the past year were inadequate. In Brussels, EU Economic and Monetary Commissioner Olli Rehn told reporters that “a comprehensive plan to contain the sovereign debt crisis” is needed, adding that failure to implement effective financial backstops would put Europe “at the mercy of market forces.”

German Chancellor Angela Merkel threw her weight behind the new effort, marking something of a reversal of her stance, reiterated as late as December, that the bailout fund need not be expanded and that future rescue efforts would be dealt on a case-by-case basis.

“We support whatever is needed to support the euro, also with respect to the bailout package,” she said in Berlin in a joint briefing with Italian Prime Minister Silvio Berlusconi. “We’re saying what we’ve always said since the Greek crisis: We will stand by the euro.”

Senior EU officials said no decision had been made on boosting the rescue fund, known as the European Financial Stability Facility (EFSF), or other measures. They will be discussed at next week’s meeting of EU finance ministers.

Ms. Merkel has been particularly sensitive about making public statements about ramping up any rescue efforts, which are not popular among German voters. As the EU’s biggest and strongest country – official figures released Wednesday confirmed that Germany’s economy expanded at record 3.6 per cent in 2010 – German taxpayers are the single biggest contributors to sovereign rescues.

Talks to bulk up the financial backstops came even as the euro zone – the 17 EU countries that share the currency – enjoyed a rare good day on the markets. Germany’s strong growth figure boosted confidence in Europe’s recovery and Portugal managed to sell debt at a slightly lower yield than expected.

Portugal raised €599-million from the sale of 10-year bonds at an average yield of 6.72 per cent, down from a yield of 6.81 per cent at a similar sale in November. But the sale of €650-million of bonds, due in 2012, at a yield of 5.39 per cent, was substantially more expensive that the 4.04 per cent demanded by investors in October.

While Portuguese Prime Minister Jose Socrates called the sale of the 10-year bonds a “success from any angle,” economists said it might only forestall a rescue. Economists at the Italian bank UniCredit estimated the cost of bailing out Portugal at €60-billion – the amounts needed to roll over debt, fund deficits and prop up the banks over the next three years.

Belgium rounded out the positive news Wednesday by unveiling better-than-expected deficit figures for 2010. The deficit was revised to 4.6 per cent of gross domestic product from 4.8 per cent as the economy came back to life. Still, Belgium’s debt costs are painfully high, suggesting that it too might not skirt debt-victim status. Its public debt stands at a hefty 97 per cent of GDP and it must pay 1.4 per cent more to finance 10-year bonds than Germany, compared with only 0.4 per cent more before the debt crisis hit.

While the EFSF is theoretically loaded with €440-billion, its true firepower is estimated at only €250-billion because of the need to set aside collateral to maintain its triple-A credit rating. That amount might be big enough to fund Ireland, Portugal and any future funding needs of Greece, which took a €110-billion bailout in May, but might be inadequate to rescue additional countries, notably Spain, the euro zone’s fourth-largest economy, and Belgium.

In a note published Wednesday, Deutsche Bank economist Gilles Moec said that “given the current market sentiment, it probably makes sense to pre-emptively increase the size of the euro rescue pot as a step to restore confidence in the European bond markets.”

Another way to boost the bailout fund would be to convince to the International Monetary Fund to contribute more to the European bailout fund. Currently, the IMF contributes 50 euro cents for every euro provided by EU countries. Japan’s announcement on Tuesday that it will buy EFSF bonds used to bail out Ireland indicate that non-EU countries and institutions are ready to ensure the euro zone’s health, economists said.

Deutsche Bank said the EFSF’s scope could be extended, allowing it, for example, to buy sovereign bonds. The European Central Bank has been buying bonds but has signalled it is not comfortable doing so.