In an article at the beginning of last week, I argued that there was a high probability that Europe's Summit talks would lead to a significant deal over a leveraged EFSF, supported by the commitment of China and the other BRIC nations. Reports from the weekend Summit now suggest that in fact such an outcome is indeed under discussion. A final agreement on precisely which route the EMU countries should take is expected by Wednesday of this week.
You can read my full article on the issue from last week here. In essence, it discussed the possibility of an all-encompassing approach to the European debt crisis via a steep haircut on Greek bonds, a resultant recapitalization of Europe's banks, an agreement to leverage the EFSF and support from China and the other BRIC nations via purchases of EFSF-related European debt.
The next few days will of course determine the precise final outcome. However, reports following the weekend Summit in Europe indeed suggest the potential for such a global-style agreement bringing in China and the BRIC nations:
In particular, Reuters now reports the following:
"The most likely method for leveraging the eurozone's bailout fund involves using it to provide bond insurance while combining its firepower with a special purpose vehicle drawing in funds from China or Brazil, European Union officials said ..."
The same report also provides the following quote from the conclusions to the Summit:
" ... 'The G20 should ensure that the IMF has adequate resources to fulfill its systemic responsibilities and should explore possible contributions to the IMF from countries with large external surpluses,' the conclusions said."
Taking the various pieces of information we now have together, it seems that we may in the end see a very significant global agreement along the following rough lines:
- An attempt to persuade the private sector to take a haircut on Greek debt of some 50-60% or so.
- A recapitalization of the banks to the tune of somewhere around Euro 100bn.
- The EFSF to be allowed to offer 'insurance' on newly issued European debt, protecting buyers in the case of a default for the first 20-30% of any future haircut or losses related to default.
- A new Special Purpose Vehicle to be set up, potentially with IMF co-ordination, to purchase EFSF-insured debt. This would in part be funded with a significant contribution from China and the other BRIC nations via their respective Sovereign Wealth Funds.
- There is now some indication that Norway's not insignificant Oil Fund will also be involved.
Such a deal is unlikely to be completely finalized before the Nov 3-4th G20 Summit in Cannes. However, the European side should be able to flesh out the key parts of the deal this week. We may see something of a volatile time. However, as the market increasingly sees the nature and significance of the coming deal, it is likely to see a further relief rally.
No deal can of course completely solve Europe's underlying fiscal and structural problems. However, a global agreement such as discussed above would certainly buy Europe's policymakers a significant period of time to address these problems. In the meantime, a global rally in stocks and the euro seems likely.