Eurozone to launch €500b bailout fund

Eurozone finance ministers launched their €500 billion permanent bailout fund yesterday, putting in place a major defence against the debt crisis that now threatens Spain.

The current IMF forecast of a 1.2 per cent recession may be revised further downwards

The fund, called the European Stability Mechanism, will be used to lend to distressed eurozone sovereigns in return for strict fiscal and structural reforms that aim to put economies that have lost investor trust back on track.

It is part of the single currency area’s drive for an overhaul of its economic structures and deeper integration. Eurozone finance ministers, who form the ESM‘s board of governors, will hold their inaugural meeting in Luxembourg two years after EU leaders endorsed the idea of setting up such a permanent institution.

The fund’s lending capacity will be based on €80 billion of paid-in capital and €620 billion of callable capital, against which the ESM will borrow money on the market to lend it on to governments cut off from sustainable market funding.

It will reach its full capacity gradually by 2014.

Its first task will be to lend to Spain for the recapitalisation of its banking sector, hit hard by a collapse of the real estate market – a programme inherited from the temporary European Financial Stability Facility.

Madrid is likely to ask for about €40 billion to recapitalise its banks following independent assessments of the sectors’ needs –well within the €100 billion set aside by eurozone finance ministers for the purpose in July.

The ESM money would flow to Spain in November, after European Commission competition authorities approve conditions for the recapitalisation for each bank.

Spain is in investors’ focus because it has struggled to cut one of the eurozone’s largest public deficits as the country sinks deeper into its second recession in three years.

In Luxembourg, eurozone ministers will also discuss a request, expected from Spain sometime in the coming weeks, for a precautionary credit line from the ESM that they hope will boost investor confidence and keep Madrid in the capital markets.

A eurozone source said they may also discuss Spain’s tough 2013 budget, outlined last month, which the International Monetary Fund and the European Commission both believe is based on an over-optimistic forecast of a 0.5 per cent economic contraction next year.

The current IMF forecast of a 1.2 per cent recession may be revised further downwards as early as today.

A revised budget based on updated IMF and EU forecasts may be one condition for assistance from the ESM.