Merkel faces hurdle after MPs oppose ESM debt buyback

Wed Feb 23, 2011 7:51am EST

Related Topics

* Coalition deputies pass non-binding resolution

* Members of parliament oppose government debt buybacks

* Analysts say could tie Merkel's hands in EZ negotiations

By Erik Kirschbaum and Sarah Marsh

BERLIN, Feb 23 (Reuters) - German ruling coalition MPs are pressing Chancellor Angela Merkel to rule out purchases of debt by the euro zone's permanent bailout fund, showing how little political room for manoevre she may have in crunch talks on the crisis next month.

Merkel has been dragging her heels on agreeing to boost the scope and size of the bailout fund, and fears of further election defeats has to pressure for her not to underwrite the debts of the euro zone's struggling periphery.

Markets for Spanish, Portuguese and other euro zone debt have been propped up by expectations that Germany would agree next month to a comprehensive plan to end the crisis.

Although non-binding, the resolution by MPs in her Christian Democrats (CDU), the Christian Social Union (CSU) and Free Democrats (FDP) recommended ruling out buybacks of government debt by the the European Stabilisation Mechanism (ESM) when it replaces the existing bailout fund in 2013.

The motion, demanding the German government not agree to any measures that could lead to a "transfer union", was laid out in a document obtained by Reuters. It will be submitted to a vote in the lower house of parliament this week. [ID:nBAT006023]

"Parliament expects that jointly financed or guaranteed purchase programmes of government debt would be ruled out for reasons of constitutional and European law, and on economic grounds," the document said, referring to the ESM.

The euro zone's 17 leaders will meet in Brussels on March 11 and bond buybacks are seen by markets and many euro zone countries as a key ingredient to any deal's success in getting on top of the year-long crisis.

But any perceived relaxation of debt terms for euro zone stragglers is a sensitive subject in a year of seven German state elections.

In the first vote in Hamburg on Sunday, Merkel's CDU suffered their worst result since World War Two at the hands of the Social Democrats. [ID:nLDE71K1CL]

MERKEL SUPPORTS CONTENT

The three parliamentary groups used the resolution to send the government a message. Merkel could ignore it, but sources say she supports much of its content. She will in any case need parliamentary backing for new euro zone aid measures.

Parliamentary sources said they discussed the resolution with Merkel and Finance Minister Wolfgang Schaeuble in advance. They also said FDP chairman Guido Westerwelle, whose party is especially sceptical about euro zone bailout measures, expressly praised the resolution as a victory for the FDP position.

Analysts said they were bewildered by the move.

"I don't think they've thought through the implications," said Thomas Mayer, chief economist at Deutsche Bank. "What do they want? It's not clear to me."

It is, however, making the temporary EFSF bailout fund able to buy bonds that is the most crucial part of what investors hope for from next month's talks. The motion did not explicitly exclude such purchases.

Mayer said if bond buying by the ESM fund was ruled out, there were three possible scenarios for dealing with those countries not able to tap financial markets.

"It's then either the taxpayer engineering a full bailout or the central bank buying all the bonds that cannot be sold in the market and taking the private sector out," he said. "The third possibility they are not addressing is one that allows an unmanaged default. But I don't think anyone wants that."

He said that if Merkel feels bound by the resolution, "we will most likely end up in a situation where we will further burden the European Central Bank with the task of funding countries that cannot access the market."

Germany has already said it will only agree new measures if they come as part of a comprehensive package to solve the crisis -- code for indebted states taking aggressive steps to among other options cut back on public spending and cap wage growth.

Fabian Zuleeg, chief economist at the European Policy Centre think tank, said the resolution could leave Merkel's hands tied.

"At the moment we need to keep all options open because there are continuing problems in certain countries where it is very hard to see how they will ever be able to deal with the mountain of debt they have got without some form of new mechanism," he said.

"I'd expect Merkel will want to keep a certain amount of flexibility in European negotiations, so I'm not sure how much influence this paper will have. Certainly it isn't helpful."

(Additional reporting by Andreas Rinke; editing by Patrick Graham)

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