Fund Strategy exposes shortfall in eurozone bail-out funds

As politicians argued over boosting the eurozone bail-out fund last week, Fund Strategy analysis revealed that the International Monetary Fund (IMF) would be unable to compensate for any shortfall if Spain and Portugal needed immediate assistance.

According to the latest figures, the usable resources of the eurozone facility combined with those of the IMF would not be enough to bail out both countries, the most troubled eurozone nations after Greece and Ireland.

Experts indicated that the European Union (EU) and the IMF could plug the shortfall by asking for new loans, possibly from Asian countries, which have already pledged support for peripheral eurozone countries.

Even loans of this nature, however, would still leave the IMF’s activities skewed towards Europe. The figures raise the question of whether it will be acceptable for the IMF, which is funded partly by poorer nations, to continue to divert billions of dollars towards wealthy ones.

According to Fund Strategy analysis, eurozone member states guaranteed €440 billion (£371 billion) of funding through their bail-out vehicle, the European Financial Stability Fund (EFSF), before Ireland sought assistance last year. The IMF had €170 billion of usable assets on October 31.

“They [European Union leaders] are still dithering”

Since then, the IMF has approved a loan of €17 billion to Ireland, the EFSF has announced it will raise up to €26.5 billion, resulting in Irish funding of €17.7 billion, and the EU will provide up to €17.7 billion, although Ireland could ask for additional resources of €32.6 billion under the terms of its bail-out.

Stripping out guarantees from the four countries that are unable to afford them, the EFSF’s resources are reduced to €357 billion, or €330.5 billion after the Irish bail-out. The IMF’s resources at the end of October, discounting the Irish bail-out, were €153 billion. The total resources of the funds combined were €483.5 billion at the end of 2010. (article continues below)

If the EU, the EFSF and the IMF lend to Ireland in the same proportions as at present, the EFSF and the IMF have joint additional liabilities of €11 billion each for Ireland.

If Portugal was granted a bail-out on a Greek or Irish scale, it would amount to between roughly half its GDP, or €83 billion, according to IMF GDP estimates. On that basis, a Spanish bail-out would cost €510 billion, the size of America’s $700 billion (then €503 billion) Troubled Asset Relief Program after the bankruptcy of Lehman Brothers.

In total, the further costs of a Portuguese and Spanish bail-out in addition to Ireland would be over €600 billion. If the funding arrangements remain the same as for Ireland, the EU would lend over €200 billion and the IMF would lend up to its ceiling of €153 billion. Under the model of the Irish bail-out, the EFSF would have to borrow over €371 billion, as it needs to cushion its lending with extra cash to receive a AAA rating.

The shortfall in the EFSF would be just over €40 billion – that is, if the EFSF and the IMF were required to assist no other countries. Azad Zangana, a European economist at Schroders, has pointed out that if Spain and Portugal were to be bailed out, Belgium and Italy would also most likely require a bail-out.

On the Greek and Irish model, removing Italian and Belgian guarantees from the EFSF would increase its shortfall by €94 billion. Bailing out Italy and Belgium would boost the shortfall exponentially.

Edwin Truman, a senior fellow at the Peterson Institute for International Economics in Washington DC, says the IMF can augment its resources using extra loans from other countries. Since 2008 it has raised $250 billion in bilateral loans and is agreeing extra arrangements to borrow of $200 billion, he says.

“On the other hand, if the EU countries are unable to finance a substantial share of any lending to euro area countries on the proportions for Greece and Ireland, then I suspect that the general memberships of the fund would be reluctant to fill the gap,” he says.

The key seems to be for EU leaders to simplify the situation for lenders and guarantee extra resources for troubled countries or lead the way in a debt restructuring. However, as Zangana puts it, “they’re still dithering”.