Business

Eurozone: Stressful haircuts

BBC business editor Robert Peston on international haircuts.

In the assessment of whether European banks are strong enough, a really important issue is what kind of discount or "haircut" should be applied to their holdings of government debt.

The final details are still being agreed. But bankers have disclosed to me that they have been told to assess the strength of their balance sheets on the basis of the following haircuts.

Greek government bonds would be written down by around 17%, Spanish sovereign debt by around 10/11%, UK government by a marginally smaller discount than on Spanish debt, French by 6%, and German by 4 or 5%.

Now two numbers stand out for me.

First, that the discount on Greek debt is only 17% - when many analysts believe it needs to be written down by nearer 50%.

And then there is the almost identical haircuts applied to Spanish and British government debt.

Now the rationale for applying similar haircuts is that both Spain and the UK had very large public sector deficits in 2009: 11.2% for Spain and 11.5% for the UK.

But, as I've pointed out before, the UK has two advantages lacked by Spain when it comes to the affordability of its debt.

First, the maturity of its existing debt is much longer than for Spain: so on top of needing to borrow to finance the gap between spending and revenues, Spain also has to refinance maturing debt equivalent to 8.7% of GDP next year, compared with 3.8% for the UK.

So from that point of view, Spain is more exposed to the whims of creditors than the UK.

Also, most economists would argue that the UK's ability to service its debts is helped by having an independent currency, which adjusts to perceptions of its economic strength, rather than being locked into the euro - as is Spain - whose value is only partly determined by the performance of the Spanish economy.

That said, according to Eurostat - the EU's statistical arm - the UK's national debt at the end of last year was 68% of GDP, compared with just 53% for Spain.

In other words, and in the round, it is difficult for the UK to argue that a significantly smaller discount should be applied to its sovereign debt in the stress tests than would apply to Spain.

Even so, it's arguably quite embarrassing for the new coalition government that European regulators believe the UK's sovereign debts are of equivalent quality to what Spain has borrowed - and significantly worse quality than French and German government bonds.

You can keep up with the latest from business editor Robert Peston by visiting his blog on the BBC News website.

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