Friday 25 May 2012

Investors pull out of Spain and Italy

TEXT-Fitch: Non-resident investors pulling out of Spain, Italy

23 May, 2012

(The following statement was released by the rating agency)

May 23 - The proportion of Spanish and Italian public debt held by non-resident investors continued to fall in the first quarter of 2012 as banks funded with cheap ECB money replaced international institutional investors, according to Fitch Ratings. We expect this trend to continue in the coming quarters.

The pace of the withdrawal by non-residents quickened in Spain, where we estimate that non-resident holdings of Spanish public debt, excluding ECB holdings under the Securities Markets Programme, dropped to 34% in Q112, from 40% at end-2011. It has been dropping steadily from over 60% in 2008.

The drop in private-sector non-resident holdings of Italian debt has followed a different path. The total outflow in Italy has been less than in Spain, with non-residents only accounting for around 50% of bondholders in 2008 and the outflow did not start until Q311. Nevertheless non-resident holdings of Italian debt have dropped to 32% and, although the pace has slowed, continue to fall.

Fitch sees a high risk of outflows in Spain and Italy continuing in the coming quarters until either a more stable base of foreign investors with higher risk appetite is reached, or economic prospects for Spain and Italy improve. The change in the investor base follows a similar shift in Ireland, Portugal and Greece, the three eurozone programme countries, and reflects a broader investor aversion to the peripheral debt markets.

The outflows have been offset by significant flows within the Eurosystem of central banks, reflecting increased use of central bank liquidity by Spanish and Italian banks. The ECB money has fulfilled a triple role of supplying banks with funding, enabling them to increase purchases of sovereign debt to replace non-resident outflows and supporting the balance of payments of these economies.

If the outflows continue, we see the ECB, and the European Stability Mechanism (ESM) if needed, as willing and able to prevent self-fulfilling liquidity crises and buy sovereigns' time to implement consolidation and structural reform, which should encourage institutional investors to return. As we have previously said, the European Financial Stability Fund (EFSF)/ESM has the capacity to act as an "anchor investor" in new sovereign bond issues, and potentially to buy bonds in the secondary market to counter these private capital outflows.

If capital outflows are not countered by these official institutions in sufficient volume, significant capital outflows would reduce the availability of credit, put pressure on borrowing costs and force a quicker economic adjustment, compounding economic problems in Spain and Italy.

The shift towards a domestic investor base in sovereign debt is one of the points discussed in the presentation The Sovereign Crisis: Where to Next? at Fitch's Global Banking Conference, being held in London, Madrid and Paris this week.

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