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Angela Merkel (centre) is to meet Mario Monti (left) and Francois Hollande (right) later this week to consider allowing the ESM to buy the bonds of member countries. Yves Logghe/AP

Explainer: Have Spain and Italy been 'bailed out'?

Germany has reportedly relented and will allow the ESM to buy bonds directly, which could save Spain and Italy.

IT’S REPORTED THIS MORNING that Angela Merkel has bowed to demand from other European leaders, and allow the European Union’s bailout funds to buy the bonds of eurozone member states.

This has been cited in some quarters as effectively sanctioning a €750 billion bailout of Spain and Italy, an unprecedented move which would be aimed at drawing a firm line under the eurozone crisis.

But what’s actually happening? What’s been agreed? And where’s the €750 billion going to come from? Let us briefly explain.

The ‘deal’ that isn’t a deal

The leaders of Spain, Italy and France – the three eurozone members attending the annual G20 summit in Mexico – reportedly reached a tentative agreement on the sidelines of the summit in Los Cabos.

Reuters said the proposal, put forward by Italy, is that the two European bailout funds – the temporary European Financial Stability Facility, which currently has lending power of about €350 billion, and the new €500 billion European Stability Mechanism - would be permitted to buy up the bonds of individual countries.

A formal deal has not yet been reached, though the proposal is to be debated at a meeting hosted by Italian premier Mario Monti later this week at which Merkel and French president Francois Hollande would also be in attendance.

While no formal deal has yet been reached, and a German government spokesman told the Independent there had been “no change” in Germany’s position, the fact that Berlin has not dismissed the plan immediately may be a sign of flexibility from Germany.

The Guardian cited a White House official who suggested that Barack Obama had been offering advice on the proposal, a voice which could add further weight to the deal.

Any common platform agreed by those countries would likely form the basis for a deal at the European Council summit of leaders the following week, and could also stimulate talks at tomorrow’s summit of Eurozone finance ministers in Brussels.

A question of firepower

Both the temporary EFSF, and the new permanent ESM due to kick in next month, already have the power to buy the bonds of individual eurozone member states.

However, both require the unanimous approval of member states – and Germany has resisted any moves to do so previously, as it fears Germany’s investment into the funds could end up being written off, if the bonds they bought were to end up being written down.

The massive buying power of the EFSF  - which has about €350 billion left to lend, after funding bailouts of Greece, Ireland and Portugal – and the €500bn ESM would be enough to drive down the yield, or interest rate, that counties pay to borrow money.

In the absence of the EFSF and ESM, only the European Central Bank has been buying the bonds of member countries – but the ECB’s rules expressly forbid it from buying the bonds first-hand, and therefore the ECB’s purchases of second-hand bonds cannot influence the yield that governments pay (which is fixed at the time the bonds are first sold).

This, in turn, could allow countries like Spain and Italy to borrow at more competitive rates and ward off the prospect of needing a full bailout.

The deal could, in theory, also allow bailout funds to buy new bonds issued by the likes of Ireland – a move which would allow Ireland to emerge from the EU-IMF bailout and issue bonds in the routine way, while not being subject to the same rigid terms and conditions that come with a bailout.

Any use of bailout funds to buy sovereign bonds, however, would lessen their ultimate ability to fund formal bailouts and could therefore prove counter-productive.

So what has been agreed?

In a formal communique issued by G20 leaders after the Mexico summit, eurozone countries affirmed their plan to take whatever actions were needed to “break the feedback loop between sovereigns and banks”.

The EU members – who were represented by European Commission president Jose Manuel Barroso and European Council president Herman van Rompuy – also affirmed their plan to make “better use of European financial means such as the European Investment Bank, pilot project bonds, and structural and cohesion funds, for more targeted investment, employment, growth and competitiveness”.

Read: Spanish auction sees cost of short-term loans rocket… again

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