Italy (and Spain) stepping out?

Yesterday Italy indicated that it might choose to “step out” of its contribution to Greece’s next tranche of bailout funding, to be delivered in mid-September. Because the second Greek bailout package will not have been approved by national parliaments by the time the next tranche is transferred, the funds will come from the bilateral loans established as part of Greece’s first EU/IMF bailout rather than from the EFSF itself. Consequently, countries can choose to step out of their contributions to the bail-out if they are facing higher borrowing costs than those at which the bail-out fund is lending. This is currently the case for both Italy and Spain. Will they go through with this, and if so what would be the implications?

It seems extremely unlikely Italy or Spain would step out of their contributions to the next tranche of funding for Greece. Italy and Spain’s ten year government bond yields have hovered around 6% the past few days, while bilateral loans are extended to Greece at just over 4%. Both Italy and Spain would be well within their rights to step out from their contributions to the next tranche of funds for Greece. However, doing so would be a tangible indication to the markets that the Italian and Spanish governments were concerned about their own borrowing costs and fiscal dynamics. Investors would likely rush to dump Italian and Spanish sovereign debt, sending bond yields ever higher.

Even if Italy and Spain opted out of participating in the bilateral loans, the impact would be minor. Their contributions would be redistributed to the other creditor countries according to size, with Germany and France assuming the largest brunt of the burden. However, the tranche of loans to be transferred to Greece in September is only €8bn, of which EU countries will contribute €5.8bn (€2.2 will come from the IMF). This is not a lot.

Assuming that national parliaments pass all of the terms of the second Greek bailout, the bilateral loans will be wrapped into the EFSF and the EFSF will loan to Greece in the future. According to the EFSF regulations, countries can only step out if they are recipients of a bailout programme themselves. Consequently if Italy and Spain were to opt out of their contributions for Greece in September, it would be a one-off event.