The institutional structure designed over the last two years by the European Union in order to confront the sovereign debt crisis is beginning to bear fruit. In exchange for “strict and effective” conditionality, according to Mario Draghi, president of the European Central Bank, the bank will purchase public debt without limits. Also, it will do so without maintaining its preferential creditor status towards private investors. 

It is still not clear, however, when this process will begin, nor what the “strict and effective” conditions will include. Also, it is not clear whether Spain will have to negotiate a new agreement, a Memorandum of Understanding (MoU), or if the already existing one will be valid only adding complements.

Also, the question remains about what level the risk premium must be at to justify an intervention by the bankers in Frankfurt. The ECB could have announced a determined differential – as did the Swiss central bank to defend the franc from its unstoppable appreciation – but it chose not to.

What is clear though is that the ECB will initiate a new era – during which its credibility will be at stake – that will mean its direct involvement in the financing of states, something that is outside its mandate and that its statute specifically forbids. The ECB, however, has a strong argument: the transmission of its monetary policy has failed - the low interest rates don’t benefit the economic agents - and it is its duty to restore it.

A respite for some weeks

“It is not normal that some countries are financed at 1.5 percent and others at 6 percent,” according to unofficial ECB sources. For this reason it is determined to intervene, although always in the secondary market, never buying emissions directly from the national treasuries, which the future European Stability Mechanism (ESM) will be allowed to do.

When these purchases will begin is currently the main question on the markets, and for now they count on a respite for several weeks. Nobody bets against the sovereign debt of the peripheral countries when the ECB announces that it will bring out its artillery to increase prices and decrease profitability, which work in the opposite directions.

However, although money is unlimited, the respite is not, and as a the head of an important think tank said, it seems clear that Spain will not request a rescue – which is an indispensable requirement for the financial help instruments to enter into effect – until after the regional elections in Galicia and the Basque country on October 21.

It will all finally depend on the degree of compliance with the public deficit target, which is the most important condition asked from the European Union. If Spain does not comply with the deficit, the ECB will not intervene, which Draghi made clear yesterday, which will leave the Spanish treasury in the hands of the markets.

If, on the contrary, the target is achieved, the government can avoid the pressure from the northern countries that want Spain, and Italy, to request financial aid as soon as possible. The slowdown of these economies because of the financial crisis, as shown in the Eurostat report on Thursday, makes this more urgent. The Eurozone economies fell 0.5 percent year-on-year and 0.2 percent compared to the previous quarter.

Not a formal rescue

The formula to solve the sovereign debt crisis does not mean a formal rescue, not even a conventional, of the Spanish economy in the way it was done in Greece, Portugal and Ireland. One of the differences is that a credit line, an Enhanced Conditions Credit Line (ECCL), can be used to intervene in the markets, according to the press release from the ECB on Thursday.

This credit line is already operational and could be activated almost automatically once the Eurogroup approves it, although the first requirement is for the Spanish government to request it. The same occurs with the European Financial Stability Facility (EFSF) and the European Stability Mechanism(ESM), although with an important difference.

The credit line – in which the International Monetary Fund participates – has less conditionality than the EFSF, compared to what the new Memorandum is likely to include. As one economist says, the credit line is ‘soft’ while the rescue mechanism is more demanding.

In both cases, however, the famous ‘men in black’of the ‘troika’ – the European Commission, the ECB and the IMF – will overlook the Spanish economy even more carefully. According to the ECB, the participation will be required from the IMF to draw up the specific conditionality for the country and the monitoring of the program.

In the meantime, it will be the ECB that continues to give loans to the banking sector, whose liquidity problem with the ECB already reaches about €375bn, loans that have been given without conditions, contrary to the ones that will be given in the near future.

This article was translated and edited by Stina Lunden.