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For Europe: ‘The Firepower Is There’: An Interview

Klaus Regling, interviewed by Sami Zeidan

SZ: If you needed more cash from the member states, how much do you think you could get?

KR: That’s impossible to say because it would depend on the needs at that point in time. And at the moment we don’t know at all whether there’s a need for more. I’m only saying that if there were, then I’m confident it would be made available.

SZ: So after all this discussion about the lending capacity that we have left at this point, it’s more or less €500 billion. The markets aren’t convinced that that is enough even in the short term, as you’ve said, even taking into consideration all the other factors you mentioned about how debts mature over the long term.

The markets are looking to the European Central Bank. Let me put the question this way: Does anybody other than the European Central Bank have the capacity to rapidly increase firepower into the trillions?

KR: I don’t see why trillions are needed at all.

SZ: Okay, rapidly increase beyond what you have?

KR: As I’ve indicated, over the next twelve to twenty-four months, not that much more is needed. But I have to make one qualification first so that there’s no misunderstanding. The €200 billion mentioned in the conclusions of the summit that will go to the IMF is not earmarked for Europe. That’s an important point. It will go to the general resources of the IMF, usable for whatever program the IMF undertakes.

SZ: So Europe will get even less than that?

KR: But other G20 countries are very likely to also make similar contributions to the IMF so it will get more than the €200 billion, but conceptually it’s important to understand that this is not earmarked for any country. It’s for the general resources of the IMF so it can use it where it’s needed. Of course, it’s true that at the moment, European countries are mainly in need of IMF resources, but this is not so unusual when you look at the IMF history. In the late 1990s it was mainly Asia that needed IMF resources. In the 1980s and the early 1990s it was mainly South America. So it happens from time to time that there’s a concentration of need in one region, and at the moment this is Europe. So that should be understood about the IMF.

Apart from that, again, the firepower of the EFSF is substantial. It will be reviewed in March in case it is not sufficient. I’m sure our governments will take that into account.

SZ: What might make it not sufficient, in your mind, when you say that it’s not sufficient? What are the factors? You must have something in the back of your mind.

KR: I have no expectation here, but markets say one country in need could be Italy; one could be Spain. But again, both countries have been able to refinance their maturing debt at an interest rate that is higher than they wish, and higher than a year ago or two years ago, but still lower than ten years or fifteen years ago, before the Monetary Union, and the important point is that they are able to refinance.

But if that were to change, then our organization would be available, together with the IMF; and the firepower certainly would be enough for a while. And then we have a review clause, so the governments of the euro-area countries would be considering further need. One more point on the available firepower that’s important: we are developing a system where we improve the efficiency of our own resources. Our EFSF resources will be leveraged by attracting private investors, if needed, into buying bonds of euro-area member states.

SZ: But as things stand now, you’re confident that with the help that you could get from the IMF, you could handle even a situation where Italy runs into trouble and isn’t able to raise money in the market…?

KR: Yes, certainly for twelve months or so.

SZ: Do you think the European Central Bank will not be forced into more aggressive buying of sovereign bonds? That scenario: you’ve ruled it out at this point?

KR: It’s very unlikely because, again, I repeat, Italy and Spain and others are able to refinance themselves at interest rates that are on the high side. Those rates should come down again. We have firepower at the EFSF. What the ECB does in the end is its decision. It’s independent. But secondly, there’s a deep conviction in the euro area that monetary financing of governments is not the right way to go. The right way to go, in this view, is rigorous budgetary consolidation complemented by structural reforms to boost competitiveness in order to achieve growth and employment.

These are principles that are enshrined in the EU treaties that gave the ECB a very strong degree of independence. The ECB is the most independent central bank in the world. We are very proud of that and we want to respect that, and nobody wants to jeopardize that status.

I think in the long run it will serve Europe very well to have a strong, independent European Central Bank that decides on its own what is needed, and what is not needed. It would have only one mandate: to guarantee price stability to avoid inflation.

And the division of labor between monetary policy and fiscal policy is much better preserved in the euro area than in the United States, for instance, where the Federal Reserve tries to achieve several objectives at the same time. The ECB doesn’t have that problem and that will serve us well in the long run. Nor, as I note in the separate statement following this interview, will it impede the EFSF‘s lending capacity, despite the recent downgrade of the rating of nine euro-area countries and the EFSF….

SZ: Let’s talk a bit about your leveraging vehicles, i.e., your plans to offer financial products that would provide (1) partial protection of risks or (2) the opportunity to take part in a fund in which the EFSF would be coinvestor.

KR: Under the partial risk protection, the EFSF would provide a partial protection certificate to a newly issued bond of a member state. The certificate would give the holder an amount of fixed credit protection of 20–30 percent of the principal amount of the sovereign bond.

Under option two, the creation of one or more Co-Investment Funds (CIF) would allow the combination of public and private funding. A CIF would purchase bonds in the primary and/or secondary markets. The CIF would comprise a “first loss tranche”—i.e., partial protection against loss in the value of those bonds—which would be financed by the EFSF.

SZ: How much money have you been able to secure from outside countries towards those leveraging options?

KR: So far we have not offered those leveraging options to investors. We have had preliminary talks about them. We are still in the final phase of developing them. There are many technical preparations that need to be done, legal preparations that are needed if these instruments are to be sold on stock exchanges. We need discussions with ratings agencies.

SZ: But have you received in your talks any commitment, any pledge?

KR: We cannot really have a pledge before we have the final product available, and also we don’t want money at the moment because we wouldn’t know what to do with the money. First, we would only need the money, this leveraged money, if we see that one or two countries in the euro area make a request for substantial amounts of money. We don’t have any such requests at the moment, so if big creditors would want to buy into our leveraged products, I have to say we don’t need the money at the moment.

SZ: How much do you think, then, after the discussions you’ve had with huge creditors and investors, that you would be able to raise through leveraging?

KR: This is very hard to say because first, again, we need a request from a country. If we have no additional program to be financed on top of Greece, Portugal, and Ireland, we don’t need any additional resources from anywhere, and don’t need to use these leverage options. Second, it’s also clear that at the moment, when the general attitude of markets toward the euro area is not very positive, it’s more difficult than if that environment changes, which I think we are hoping for, based on all the good decisions made by the summit in December. So there are several variables that are at play here.

SZ: You’ve already made trips to some of these big creditor nations, haven’t you, like China. What sort of response did you get there?

KR: Well, I talk to important investors around the world and I know those investors who have bought EFSF bonds in the past, on the several occasions that we issued bonds. Some of these big investors are in Asia. And what we have discussed with them is how we need to structure these leverage options so that they are accepted by the markets at the time when we want to offer them. That was the main purpose of my colleagues and me traveling to large investors in the past. We continue to do that. But it was not the moment to ask for concrete pledges.

SZ: Aside from concrete pledges, did you get any indication when you went to China that people there would say yes, we would be interested once you launch this leverage option, we’ll be interested in buying some of it?

KR: Yes. I had a lot of interest from investors, not only in China, but also from investors like insurance companies who very much like the insurance-type leverage options that we are also developing, and there have been statements, public statements, from some of the biggest insurers in the world like Allianz and Generali and Axa that say, “Yes, once you offer that product on the market, we’ll look at it very positively.” So we have had expression of these kinds of interests, general interests, but again, it is too early to have precise pledges.

Let me emphasize again. The summit in December made important decisions, and the euro area is taking major actions to address the crisis. It has strengthened the financial backstops for its debts; member states are making progress on fiscal consolidation and structural reforms to boost potential growth, and they have agreed on a new fiscal compact on binding national rules concerning balanced budgets. The ECB has taken significant additional measures and the EU is following up on decisions to reinforce the banking system. I am convinced markets will appreciate Europe’s efforts to restore financial stability and investors’ confidence in the euro area.

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