The renewed debate of debt mutualisation threatens to create new cracks on the European project.
We believe a policy debate poses a potential threat to the European Union project. The debate is centered on whether and how to mutualise the public expenses needed to face the sanitary and economic Covid-19 emergency.
The differences among governments have been growing to the point where the issue has become a potential threat to the unity of the European Union.
On March 24th, the meeting of the Eurogroup, a gathering of Ministers of Finance of the countries sharing the Euro, was unable to reach common conclusions and the issue was sent for discussion to the Leaders at the European Council.¹ The European Council, on March 26th, was equally unable to reach an agreement and sent it back to the Eurogroup, asking them to report back within two weeks.²
With this in mind, the stakes for the upcoming Eurogroup meeting, scheduled for April 7th are very high.
We believe markets will follow up closely these events as sovereign spreads move accordingly to the more or less positive outlook of the negotiations.
In our view, the debate revolves around three alternatives: first, the status quo; second, recourse to the European Stability Mechanism (ESM); and third, the creation of some form of Eurobond.
The defenders of the status quo can rely on the asset purchase launched by the European Central Bank (ECB) in the last few weeks, which amounts, through different programmes, to more than a trillion Euros until the end of the year³. The existing Asset Purchase Programme (APP) and Pandemic Emergency Purchase Programme (PEPP) cover a very sizeable amount of the countries’ issuance this year⁴. In addition, some of the constraints which have tied the ECB’s hands in the past have either been removed or made more flexible. However, we believe this mechanism is seen by many as far from perfect. Some others lament that once more the response to the crisis has been left exclusively to the central bank and that, even in the presence of a another crisis, the European Union is not able to come up with risk sharing initiatives. Market operators also note as well that the ECB is buying only on the secondary market with governments issuing on the primary market, which can create tensions on banks and interbank markets.
Recourse to the European Stability Mechanism
The second option, as outlined above, is the ESM, a treaty-based mechanism created during the sovereign debt crisis of 2010/2012 to provide financial assistance to Eurozone countries. Its most well-known use has been providing loans within a macroeconomic adjustment programme to Greece and other peripheral countries. The ESM could deploy up to €410 bn⁵ in today’s emergency and it could also rely on the ECB as final buyer of the debt through a specific mechanism called OMT (Outright Monetary Transactions). But, in order to activate the ESM, a country must accept a specific and quite articulated programme of reforms (so called “conditionality”) and submit itself to a system of verifications and inspections from the European Stability Mechanism / European Counsel / European Central Bank (so called “European Troika”).
We believe that in the current environment, this mechanism is seen as politically “toxic” in most European countries and it is unlikely that access to ESM could be authorised by national parliaments. Within the ESM framework, there are other tools which could potentially be explored. Could these tools with a “conditionality light”, e.g. targeting the funds exclusively to the emergency, become a more palatable option for southern European countries?
The Third Option: Debt Mutualisation
The third option has to do with the principle of full mutualisation. On March 25th, leaders from nine countries, including France, Italy and Spain, sent a letter to the President of the European Council, stating: “We need to work on a common debt instrument issued by a European institution to raise funds on the market”.⁶ They were referencing the Coronabonds/Eurobonds which implies bond issuance by a centralised European entity. In the same way as, single countries can issue on public markets, a European entity would go to markets and raise funds by issuing these instruments. This entity should be provided with adequate repayment capacity and the debt would be fully on its books. Germany together with other Nordic countries have been traditionally very reluctant to accept any form of debt mutualisation and they do not seem to have changed position lately.⁶ There are possible variations of this mechanism, but none of them so far have been considered acceptable for these countries.
By the April 7th, Eurozone countries must decide which of these options to pursue. If an agreement cannot be reached, the status quo will prevail. In that case, we believe the ECB will be left, once more, as the only bastion to protect the stability of the Euro and a new deep crack would have appeared within European solidarity.
Markets will likely take note of this.
1.Remarks by Mário Centeno following the Eurogroup videoconference of March 24, 2020 https://www.consilium.europa.eu/fr/press/press-releases/2020/03/24/remarks-by-mario-centeno-following-the-eurogroup-meeting-of-24-march-202
2.Joint statement of the members of the European Council, March 26, 2020 https://www.consilium.europa.eu/en/press/press-releases/2020/03/26/joint-statement-of-the-members-of-the-european-council-26-march-2020/
5.Source: FT Eurozone chiefs look to €410bn bailout fund for help as of March 16, 2020.https://www.ft.com/content/cf4679b6-67c5-11ea-800d-da70cff6e4d3
6.Nine eurozone countries issue call for ‘coronabonds’, FT, 25 March 2020. https://www.ft.com/content/258308f6-6e94-11ea-89df-41bea055720b
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