March 25 (Bloomberg) -- European Union leaders cut the startup capital for the future euro emergency aid mechanism after German demands to make smaller upfront payments stoked fresh concerns about Europe’s effort to quell the debt crisis.
As speculation swirled that Portugal will be the next victim of the crisis, the leaders bowed to German Chancellor Angela Merkel’s call to pare the fund’s paid-in capital as of 2013 to 16 billion euros ($23 billion), less than the 40 billion euros foreseen in a March 21 accord.
“It was a difficult debate with Germany,” Luxembourg Prime Minister Jean-Claude Juncker told reporters after the first session of an EU summit in Brussels early today. “Germany found that in the compromise agreed last Monday it would have to pay in too much. So we had to tackle that issue.”
With Merkel’s party trailing an opposition bloc in the polls before a March 27 regional election, the sparring over the future emergency support system reflected domestic political pressure on leaders in Europe’s wealthier north to limit aid to struggling southern economies.
Merkel’s renegotiation of the three-day-old financing accord punctured the EU’s proclamation of a “comprehensive” anti-crisis strategy, including tougher sanctions on excessive budget deficits and national pledges to increase competitiveness.
German political jitters over propping up debt-swamped states dominated the crisis response last year, with Merkel delaying aid for Greece and calling for bondholder losses that hastened Ireland’s plunge into the fiscal abyss.
Portugal, for example, navigates the next phase of the crisis with the government’s powers in doubt after the defeat of a budget-cutting plan in parliament on March 23 led Prime Minister Jose Socrates to offer to step down.
Downgrades by Fitch Ratings and Standard & Poor’s dealt a further blow yesterday, as EU leaders called on Socrates and the opposition parties to unite behind belt-tightening measures that might spare Portugal from becoming the third euro country to tap emergency aid.
Standard & Poor’s might take struggling countries down another notch, since the future fund -- known as the European Stability Mechanism -- will outrank private bondholders, said Moritz Kraemer, managing director of European sovereign ratings in Frankfurt.
“We would reassess the ratings specifically of Greece and Portugal, which we think are the most likely potential customers of the ESM,” Kraemer said on Bloomberg Television today.
Portuguese bonds fell for a fourth day today, pushing the 10-year yield up 13 basis points to 7.79 percent. The extra yield over German bonds, a sign of the risk of investing in Portugal, rose 10 basis points to 452 basis points.
Socrates “made it clear in the most likely case that there will soon be elections in Portugal, he’s sure that whatever will be the next government all the commitments in terms of fiscal targets will be respected,” said European Commission President Jose Barroso, a former Portuguese leader.
Portugal continued to rule out a bailout, which two officials with direct knowledge of the matter said may total between 50 billion euros and 70 billion euros.
Portugal’s situation is “precarious,” Belgian Prime Minister Yves Leterme said.
Split in Alliance
The German move on the emergency fund split the six-country alliance of AAA-rated countries that shoulder the bulk of the rescue costs. Political sensitivity is high in Finland, part of the top-rated club, where polls show a surge in support for an anti-euro party in the run-up to April 17 elections.
Finnish Prime Minister Mari Kiviniemi told Bloomberg Television before the summit that she would oppose a deal that “increases any country’s responsibilities.”
Cash contributions to the future fund will amount to 80 billion euros spread over five equal annual installments. Another 620 billion euros will be callable, to give the fund an AAA rating with a lending capacity of 500 billion euros.
Isolated in the summit debate, Germany accepted a provision enabling the fund to make up any capital shortfalls during the startup phase by requiring euro governments to accelerate contributions of cash or “appropriate instruments” such as bonds to maintain a lending buffer.
The revised financing arrangements are unlikely to jeopardize the goal of an AAA rating for the fund, said Silvio Peruzzo, an analyst at Royal Bank of Scotland Group Plc.
“They made it quite clear that it’s absolutely important to them to make sure the rating of this vehicle is AAA,” Peruzzo said. Germany is “the biggest player and they’ve got the most cash and they’ve imposed most of the conditions.”
While leaders renewed a pledge to bring the firepower of the current temporary rescue fund up to a planned 440 billion euros by June, they didn’t spell out how that will be done. Set up at the height of the Greek phase of the crisis last year, that fund is limited by collateral rules to lending only 250 billion euros.
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