The European Union on Tuesday agreed to spread a massive 700 billion Euros permanent financial safety net to bailout Eurozone nations facing liquidity crisis and thereby stave-off future sovereign debt crunch endangering their stability.
The new rescue fund — European Stability Mechanism (ESM) — will replace the present €440 billion temporary financial shield — European Financial Stability Fund (EFSF) — when it expires in mid-2013.
It was set up a year ago to prevent the debt crisis in Greece from spreading to other debt-ridden countries in the Eurozone such as Ireland and Portugal.
The EU finance ministers finalised the terms of the proposed rescue fund as Greece struggled to avert a bankruptcy a year after receiving a 100 billion euros bailout from the EU and the International Monetary Fund in May, last year.
The Eurozone finance ministers, who met in Luxembourg on Sunday, delayed a decision to release the fifth tranche of that assistance amounting to 12 billion euros until the Greek government introduces further measures to stabilise the nation’s crippled economy.
Even though the EFSF has €440 billion at its disposal, its actual lending capacity was around €250 billion because the rest was needed to be strong enough to keep its borrowing cost low.
Therefore, the finance ministers decided to raise its effective lending capacity to €440 billion, they said in a statement. So far, Ireland and Portugal were rescued from bankruptcy with the support of funds from the EFSF.
The proposed new rescue fund will be comprised of €620 million in credit guarantees and €80 billion in cash from the Eurozone member nations. The cash payment will be made in five equal tranches during the period between 2013 and 2017, the statement said.
The ESM will have an effective lending capacity of €500 billion. It is also expected to get funds from the IMF which currently has a 250 billion Euro share in the existing rescue fund.
“Our agreement demonstrates the determination of the Euro zone nations to do everything to safeguard the stability of the Euro area,” Jean-Claude Juncker, chairman of the 17-nation group, said at the conclusion of their meeting.
The proposed new fund aims to involve for the first time private creditors such as banks, investment funds and insurances in future bailouts to reduce their costs for the taxpayers.
As the largest contributor, Germany will have to undertake guarantees for €168 billion and provide a cash payment of around €22 billion.
A basic decision to set up a permanent financial rescue fund for the Eurozone nations was taken by the heads of state and government of the European Union at their summit in March.
They had agreed then that cash-strapped Eurozone nations will be rescued from bankruptcy only as the “last resort” when the stability of the entire Eurozone is in danger. They also wanted to involve for the first time private investors in future bailouts.
The Eurozone finance ministers said they expected to release the next trance for Greece by mid-July, but before that they wanted to ensure the government of embattled Greek Prime Minister George Papandreo survives a vote of confidence today and the parliament approves spending cuts and savings of around €28 billion.
Greece urgently needs the latest tranche to avoid defaulting on debt repayments due next month. It will also ensure that Greece will remain solvent until September.
The ministers also acknowledged Greece’s needs for a second multi-billion rescue package because it will not be in a position to raise funds from capital markets at least until early next year. They agreed that the proposed bailout will include private creditors for the first time on a “voluntary basis.”
Mr. Juncker said after Sunday’s meeting that Greece will get the next tranche as well as a second rescue package from the EU if the Greek government takes the appropriate decisions and implement them.
The heads of state and government of the European Union are expected to agree on the key aspects of a second bailout ranging between €90 billion and €120 billion when they hold a summit in Brussels on Thursday and Friday.