ESM kicks off as its first client keeps low profile

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Eurozone finance ministers meeting in Luxembourg launched the European Stability Mechanism (ESM) yesterday (8 October), a €500-billion rescue fund for the 17 countries that share the currency. Its first task will be to help Spain recapitalise its banks, but reportedly no discussion took place about Madrid needing a full bailout.

The ESM, which replaces the temporary EFSF (see background), 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.

"The start of the ESM marks a historic milestone in shaping the future of the European monetary union," the fund's chief executive, Klaus Regling, told reporters

"The euro area now is equipped with a permanent and effective firewall, which of course is a crucial component in our strategy to ensure financial stability in the euro zone."

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.

From Monday it has a capacity of €200 billion. 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 (EFSF).

No bailout?

The eurozone has already set aside €100 billion for Spain to recapitalise its banks, only around €40 billion of which is expected to be used in the coming weeks, but there are also expectations in financial markets that Madrid will also have to request a government bailout in the coming weeks or months.

German Finance Minister Wolfgang Schäuble said as he arrived for the meeting that Spain was not asking for help and did not need it, a message reiterated by other ministers. But Prime Minister Mariano Rajoy has said he may have to request help if Spanish borrowing costs remain too high for too long.

Spanish 10-year bond yields are currently at around 5.75%, a level that is sustainable for the government. But a borrowing cost substantially above 6% for an extended period of time could force Rajoy's hand.

"I think we should deal with such a request when it comes, but so far the Spanish government is undertaking reforms which go in the right direction," Luxembourg Finance Minister Luc Frieden said as he arrived at the meeting.

Juncker said there had been no discussion about Spain needing a sovereign bailout on top of its banks.

As well as Spain's broad financial needs, Monday's meeting touched on the budget goals presented by Rajoy's government last month, which the European Commission has yet to endorse.

The Commission will publish its twice-yearly economic forecasts on 7 November and some officials have said it may conclude Spain can't meet its budget targets, which are based on the economy contracting by an optimistic 0.5% next year.

The IMF forecast of a 1.2% recession may be revised further downwards on Tuesday.

Germany is the biggest contributor to the European Stability Mechanism (ESM), an important tool to stem the three-year debt crisis that has forced bailouts of Greece, Ireland and Portugal and now threatens big countries like Spain and Italy. ESM is funded by taxpayers' money.

In exchange for Germany's solidarity with troubled eurozone member states, German Chancellor Angela Merkel has obtained a new European treaty to tighten fiscal discipline in the eurozone and deepen economic integration as a way to address the bloc's sovereign debt crisis.

Germany was the last country in the 17-member eurozone to complete the ratification of the ESM. According to the German Constitutional Court ruling, the German parliament would have veto rights over any increase in Berlin's contribution, which is capped at €190 billion.

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