Monday, November 12, 2012

Portugal shut out of OMT in order to keep Greece out

In late August JPMorgan argued that the ECB's OMT (Outright Monetary Transactions) program should start with Portugal (see discussion). The prediction was wrong - the ECB disqualified Portugal from participating. But why? After all Portugal has complied with multiple troika reviews and the monetary transmission mechanism in Portugal has clearly been broken. The chart below shows that Portugal's private sector has not benefited from the ECB's liquidity injections (LTRO) and the lower overnight rate (prime example of broken monetary transmission).

Source: JPMorgan

What's particularly strange is that the whole justification for the ECB launching this sovereign bond buying program to begin with had to do with problems of monetary transmission (see discussion) in the Eurozone.

Draghi's explanation for keeping Portugal out of OMT is that the nation lacks "complete market access" - meaning that it can't sell bonds in the market. And only the nations that have such access qualify for the program.
Draghi (ECB):  - "Portugal is an example of the significant progress that I have hinted at before, of the very, very significant progress that has been achieved. Moreover, the overall situation, politically speaking, is a strong situation. Obviously, we also fully share the concerns that have been expressed about the difficult social situation, but the reform agenda is firmly in place. The OMT would not apply to countries that are under a full adjustment programme until – and that is what I believe I said last time – until full market access, complete market access has been obtained. And this is because the OMT is not a replacement for a lack of primary market access. By the way, on this front, among several pieces of positive news that we have had in the last few days, we had one piece on Portugal, namely that, yesterday, for the first time, a three-year bond was issued, which is not complete market access, but it marks the beginning of complete market access, so that it is actually a reassuring bit of news."
This is quite strange. Portugal can in fact issue some short-term bonds, but that doesn't qualify as "complete" access to the market, shutting Portugal out of OMT. This past summer however Spain could not sell long term bonds either, focusing instead on issuing short-term paper. Yet somehow Spain qualifies? Now Spain has full access to the market, but ONLY because of the ECB's backstop. In fact if Portugal qualified for the OMT program, it would immediately gain full access to the market as well. This argument is a bit circular, isn't it?

One explanation that JPMorgan offers for this strange policy by the ECB has to do with Greece. If Portugal were allowed into the "OMT club", Greece would want in as well. The Eurozone leadership however (particularly in Berlin) has nightmares about the ECB buying Greek debt - and then risking restructuring (which is quite likely and in fact warranted - see discussion). The ECB has lost its independence and is now trying to maneuver the halls of Eurozone's politics.
JPMorgan: - So why did the ECB design the OMT this way? One possibility is that the ECB felt that applying the OMT to Greece would be inappropriate given questionable program compliance. And perhaps it was more convenient to apply a general stricture about market access, which would disbar Greece from OMT for the foreseeable future, than to state the ECB’s misgivings about Greek support openly.
This is rather sad. In order to appear apolitical, the ECB applies this strange general rule that would keep Greece out of OMT. And Portugal is sacrificed in the process.

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