Why it does not make sense for Italy to access the European Stability Mechanism
Senior Fixed Income Strategist
Summary: In order to understand whether it makes sense for Italy to access the European Stability Mechanism (ESM) it is necessary to understand what will be the country's cost of borrowing through the ESM versus its actual cost of funding.
On Monday the ESM has issued EUR 7bn 12-months Bills at a yield of -0.432% . One day later, Italy issued EUR 7bn BOT with 12 months maturity at an average yield of 0.238% . Therefore, ESM’s cost of funding is 67bps cheaper than Italy’s. However this advantage tightens up as we add ESM’s various fees.
The ESM, on the top of the base rate which reflects the ESM’s cost of funding, charges the borrower the followings :
- Margin charged for the loan disbursed: 10bps annually
- Up-front service fee: 25bps
- Annual service fee: 0.5bps
Therefore, the advantage to borrow from the ESM against issuing BOTs ends up to be only of 27bps, bringing the borrowing cost around zero of a county that already can raise capital without issues at a very low interest rate.
Besides saving up a ridiculously small amount of money, the borrowing country has to accept the followings:
- The margin can vary according to the ESM’s investment policy changes, therefore Italy’s overall cost of borrowing can surge. This is what happened to Spain between 2013 and 2014. Spain started in 2013 to pay a lending rate to the ESM of approximately 40bps, but it ended up paying 100bps in 2014 as the ESM shifted its investment policy from issuing short-term securities to longer-term funding instruments .
- Money will not be available straight away. Italy can borrow up to 2% of 2019 GDP, this amounts to EUR 36bn. However, the ESM will give Italy up to EUR 5.4bn per month. This means that it will take 7 months to get the full amount. At the moment Italy does not have liquidity constraints and if BOT issuances are as successful as the one of this week, the country will be able to raise this money by itself.
- Klaus Regling made it clear that once the loan will be granted there will be surveillance in order to guarantee the solvency of the borrower (exactly as a regular bank would do). The borrowing country therefore has to respect ESM’s economic guidelines, otherwise punitive measures will be applied. Ultimately, the only way to be in line with ESM’s guidelines means to gradually reduce public debt, which is a strategy Italy will not be able to pursue at the moment.
Quarterly Outlook Q2 2022
Quarterly Outlook Q2 2022: The End Game has arrived
- Shocks from covid and the war in Ukraine have forced the global financial and political world to change, but what will the end game be?
Energy crisis could turn energy stocks into secular winnerWith long-term expected returns for the global energy sector close to 10%, we look at 40 stocks that could be set to cash in.
The great EUR recovery and the difficulty of trading itIf the terrible fog of war hopefully lifts soon, the conditions are promising for the euro to reprice significantly higher.
Tight commodity markets – turbocharged by war and sanctionsWith supply already tight, commodities keep powering on. But will it last for yet another quarter?
Between a rock and a hard placeGeopolitical concerns will add upward price pressures and fears of slower growth, while volatility will remain elevated.
The Great ErosionInflation is everywhere and central banks try to combat it. But will they get it under control in time?
Australian investing: Six considerations amid triple Rs: rising rates, record inflation and likely recessionWhile global financial markets are struggling in an uncertain world, the commodity-heavy Australian ASX index is poised to keep a positive momentum.
Cybersecurity – the rush to catch up with realityWith the invasion of Ukraine, governments and private companies are rushing to reinforce their cyber defenses.