–Statistical Move Would Push Up Debt-To-GDP Ratios Across Bloc

By Emma Charlton

BRUSSELS (MNI) – The European Union will decide on a case-by-case
basis whether to let its member countries count nationalised bad-bank
assets as part of their government balance sheet, an EU spokesperson
said, paving the way for a series of statistical revisions which could
push up government debt ratios across the bloc.

As inter-bank lending dried up during the financial crisis, some of
the most vulnerable institutions were partly or completely nationalised,
including Germany’s Hypo Real Estate, UK-based Royal Bank of Scotland
and Ireland’s Anglo Irish Bank.

Lurking on their balance sheets were heaps of “bad” or “toxic”
assets, including loans to companies and consumers that would never be
repaid. In many cases, these assets were split off and treated as
separate vehicles to allow the functioning part of the business to
survive as a separate entity.

Now, governments can apply to Eurostat, the EU statistics agency,
to be allowed to consider the vehicles containing the bad assets as
government debt, increasing their already inflated public debt-to-GDP
ratios.

The German government on Thursday said it plans to do just that,
including the bad assets of nationalised WestLB and Hypo Real Estate in
its projections for gross debt, on the basis of a Eurostat
recommendation.

“Statisticians examine each case carefully, [based] on the facts,”
said European Commission spokesman for Economic and Monetary Affairs
Amadeu Altafaj Tardio.

“Eurostat will provide advice to countries if requested,” he said,
noting that in the German case, Eurostat has advised that the assets and
liabilities of the body set up to contain bad banking assets be added to
the government’s balance sheet.

“The liabilities all add to Maastricht Debt on a gross basis,” he
added.

WestLB’s assets are already included in the government’s
projections for its gross government debt, but the bad assets of Hypo
Real Estate, estimated at over E200 billion, have yet to be added,
German Finance Ministry sources said.

According to German weekly Die Zeit, this could boost the country’s
debt ratio to 90%. That is above than the government’s current
projections for a peak in debt at 80.5% in 2012 and 2013 and well above
the EU ceiling of 60% set out in the Maastricht Treaty.

As the EU’s largest economy with one of the most ambitious fiscal
consolidation strategies, Germany is in better position to do this than
many of its neighbors.

Weaker economies with bigger banking problems and higher debts and
deficits, like Spain and Ireland, would risk aggravating market concerns
if they decided to take a similar route.

Market worries about Europe’s high debts and deficits and the state
of its banks triggered a steep slide in the euro this spring.

Countries like Ireland, Spain and Portugal adopted strict austerity
plans to reassure markets that their public finances were under control.
Greece agreed a deal in May to receive loans worth E110 billion over
three years from the Eurozone and the International Monetary Fund in
exchange for a draconian austerity program.

Ireland’s public debt-to-GDP ratio is forecast by the International
Monetary Fund to rise to 96% of GDP by 2012. Irish Central Bank Governor
Patrick Honohan recently estimated the total cost of bailing out the
banks at E25 billion, around 16% of its GDP.

A recent report by the Economic and Social Research Institute
estimated that the one-off costs of bailing out the banks would lift
Ireland’s government deficit from around 11.5% of GDP to 19.75% — way
above the Maastricht limit of 3%.

Markets are on alert to this issue because Ireland’s bank guarantee
scheme set up in September 2008 is set to end in December and needs EU
approval to be extended.

In Spain, there is concern about the funding of unlisted savings
banks, known as cajas, five of which failed European Union stress tests
last month and now need to raise additional capital.

On top of that, the Spanish government is in the process of
implementing a controversial plan to cut its budget deficit to 6% of GDP
this year from 11.2% in 2009.

In a recent report, the IMF warned that Spain’s economic recovery
will be “fragile and weak,” with GDP shrinking 0.4% this year and
pockets of weakness remaining in the banking sector.

Renewed concerns over debt levels, economic recovery and banking
assets have combined to increase volatility in the sovereign debt
markets. Irish 10-year bond spreads have widened 56 basis points since
August 2 and two-year spreads expanded 90 basis points. In Spain 10-year
spreads have widened 28 basis points over the same period.

“The recent move in Irish bonds against Bunds has been swift, with
spreads moving out to the recent wides,” said Nomura fixed-income
strategists in a note to investors. “It is a reminder to the market that
although the initial hurdles of stabilising the bond market have been
overcome, there are potential risks.”

“Tightening spreads do not mean that resolutions to European debt
levels and economic issues have been reached,” the analysts cautioned.
“Structural reform, particularly in the peripherals, is a medium- to
long-term process, a process which is only just underway.”

–Brussels: 0032 487 (0) 32 803 665, echarlton@marketnews.com

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