What happened after the outbreak of COVID-19?

Past March the 25th, nine European leaders from Italy, France, Spain, Slovenia, Portugal, Greece, Ireland, Belgium, and Luxembourg sent a request to the European Parliament asking for some funds aimed at restoring the economy after the coronavirus outbreak with hypothetical tools called “Coronabonds”. This tool should be as efficient in the long run, as well as powerful enough to face the crisis. The severity of the situation and the necessity for a reinforcement of the economies are key to let them have a better starting point in the upcoming future. 

There is the need for a common efficient and unified response to the situation in order to have the possibility of ‘exploring’ other tools from the internal EU balance, as a specific fund for expenses due to fighting the corona at least for 2020/2021, aside from the ones already requested to the committee.

What are bonds?

Simply put, they are obligations. The states request loans to finance their activities. There are two kinds of bonds: ordinary ones ( used for pensions, sanitary or citizen services) and extraordinary ones (as for the Coronavirus situation). Big companies, international funds, banks, or investment foundations buy government bonds and loan the money. The buyers decide the country in which to invest through the interest rate.

What are the Eurobonds?

They are financial tools in which emission is possible through a solid union of the countries. The essence of the Eurobonds is that a company can choose any country to issue them depending on the specific economic and regulatory environment. What makes the bonds attractive among investors is a small notional amount of a bond, which means that the bond is relatively cheap to obtain. When a Eurobond is issued, the debts of the single states become common debts which makes it more convenient for the more unprivileged states. 

What are the Coronabonds?

Coronabonds are obligations emitted strictly for the Coronavirus emergency, to help limit the spread of the virus  As a first step, they are mainly meant for maintaining sanitary structures, affording healthcare personnel and scientific research, as well as all first aid tools needed to face the emergency, such as masks and gloves. 

The second step includes a long-term perspective, regarding the restoration of the country’s economy, by providing common funds aimed at coping with the huge awaiting recession.

It is important to specify that we are talking about economic terms with which both intend the possible joint emission of government bonds, granted for all the eurozone countries. The main known difference between the two is that Coronabonds are not yet well defined due to the scarcity of their existence. Nevertheless, they are financial assumptions that might work on dozens or thousands of milliards of Euro. 

Currently, the definition outlining what they should be in the understanding of the nine countries that signed the request is a debt tool to face the economic fallout issued by a European institution for all the member states. A revolutionary proposal that would place all the countries at the same level addressing all the participants with the same interest rate for payments to be done. 

Although the 12th March the European Central Bank president Christine Lagarde addressed €120 billion and the 18th March additional €750 billion for the PEPP (Pandemic Emergency Purchase Project) proving that the support is being applicated but with relevant restrictions concerning the shares on the national debt; the most affected countries by the CoVid19 pandemic are still necessitating more assistance from the European Institutions. 

For instance, the countries defended themselves stressing that the whole world is facing a tremendous crisis related to a natural disaster that no one is responsible for, and this is the moment when the Union needs to show how to work as a unified and coordinated organization as it never was before. Everyone affected is standing in front of an ‘external symmetric shock’ as it was referred like in the letter. The reaction to this pandemic should be equal in all the countries with similar financings. But this repercussion would mean the risk of mutualization, hence the share of the debt between multiple states. Consequently, the aforementioned slowed down the negotiation on the matter. 

However, countries like Italy denoted that they are not intending at letting others pay their debts. For the Italian Prime Minister Giuseppe Conte there are no intentions to recur to the mutualization. Their idea on the matter is to divide the public debt from the crisis situation as the single countries will face it individually. 

At the same time, prosperous countries like Germany, The Netherlands or Austria are still being resistant that indigent countries could induce all the member states into more debts. Even if the concern remains, Paolo Gentiloni, the European Commissioner for Economy, ensures that a general division of public debts would be impossible to approve. The agreement remains to be done focusing on common resources for shared objectives, as for the aforementioned  Coronavirus economic crisis needing funds for sanitary tools, unemployment, or enterprise support. 

Apart from the complications relating to this matter, it is globally understood that the most affected countries do need help, on that account the EU Commission is willing to announce a European layoff amounting until €100 billion. The ongoing pandemic is testing the concept of European solidarity.

In this scenario, the ‘SURE’ Project ( State sUpported shoRt-timE work) was created, which shows the willingness of cooperation and assistance after numerous disagreements mainly relating to job support. 

What are the possible solutions that came out of the EU Council?

Thursday, April the 9th, The European Economy ministers took part in a meeting which intention was to find a common solution. The main conditions proposed by The Netherlands and Germany to accept the mutual aid project were the complete rejection of the Eurobonds (not Corona Bonds)  and non-acceptance of the shared public debt.  The final outcome has seen the emanation of three main security agents: SURE; a strengthening project and ESM.

Regarding the prior mentioned SURE, it is a project for work support of €100 billion. As for the strengthening project it is designed to meet the needs of small and medium enterprises amounting to €200 billion. The latter one is intended to cover the sanitary expenses related to Covid19. The use of those aid tools implements economic supervision on the country who is requesting it, of the European Troika (a group of three European institutions European Commission, European Central Bank, International Monetary Fund) and an amount of 2% out of the country’s GDP.  Focusing more on the above-mentioned, it is plausible to further analyze it. 

 What is ESM?

The European Stability Mechanism is an intergovernmental organization which operates under public international law for all eurozone Member States having ratified a special ESM intergovernmental treaty. Its mission is to provide financial assistance to euro area countries experiencing or threatened by severe financing problems by borrowing money on financial markets which are guaranteed by 704.8 billion Euros (its capital, as authorized by the Members).

This assistance is granted only if it is proven necessary to safeguard the financial stability of the euro area as a whole and of ESM Members. It is based in Luxembourg, it has 155 staff from 35 countries including the United States, China, and Brazil.

What support has the ESM provided? 

Combined with the EFSF, it has disbursed €250 billion in loans during the current crisis, more than three times what the IMF disbursed globally during that period.  It is one of the largest issuers of euro-denominated debt in the world. 

During Europe’s sovereign debt crisis the ESM’s first programme was a loan to Spain to help strengthen the country’s banks. The ESM paid a total of €41.3 billion in December 2012 and February the following year. The final repayment is due at the end of 2027. 

The ESM’s only other programme so far was for Cyprus. The total available is just under €9 billion. So far €5.7 has been paid. The money is to support the government’s financial needs and for the recapitalization of the financial sector.

Without this help, some of these countries, including also Greece, Ireland, and Portugal would have needed to leave the euro.

Are there conditions attached to financial assistance? Yes, there are. The policies that the borrowing country is required to follow are negotiated on a case-by-case basis. 

In the case of Spain, the conditions were focused on the banks. With Cyprus, the conditions were more wide-ranging and covered tax, government spending, and healthcare and pension reform.

How does ESM work?

The ESM lends hundreds of billions of euros to programme countries, but this does not cost taxpayers any money, because the ESM raises the money it needs in financial markets, by selling bills and bonds to investors all over the world. 

Once the money is in our accounts, the lending team passes it on to programme countries. This happens only under strict conditions. Countries must implement tough reform programmes before they get ESM money and each step is scrutinized by the mission chiefs, who regularly visit the programme countries.

The relationship with these countries is a long-term one, because of the long maturities of our loans. Through the so-called Early Warning System, the ESM country teams continuously monitor countries’ ability to repay the loans.

ESM and COVID-19 crisis

The solution for coronavirus-stricken economies could be for euro-area countries to apply to ESM precautionary credit lines. Given the need for unanimous approval by the ESM Board of governors (ie, the Eurogroup), that would provide the ECB with a political validation to implement unlimited and targeted OMT (Outright Monetary Transactions). An ECB OMT programme should be sufficient to ensure that countries can finance themselves easily and cheaply.

But countries facing higher funding costs than the ESM could also draw on their ESM credit lines in order to benefit from lower rates. At the end of February 2020, the ESM issued a 10-year bond with a 0.01% coupon rate and could pass this low funding cost to all countries with a relatively small fee. In addition, the maturity of ESM loans could probably be longer than what the market could offer. As a result, the combination of those two elements would slightly improve the sustainability of the debt and reduce the roll-over risk.

This is the option currently pursued by the Eurogroup which on 24 March proposed to the EU Council to offer Pandemic Crisis Support (PCS) credit lines from the ESM to individual countries. The current Enhanced Conditions Credit Line (ECCL) would serve as a basis for these credit lines.

Nevertheless, we see three significant drawbacks related to this option.

  • The first problem would be the relatively small firepower of the ESM (€410 billion) currently, and the Eurogroup proposal mentions an even smaller 2% of GDP, around €240 billion, dedicated to the PCS for the moment). This would drastically limit its capacity to reduce the debt service of euro-area countries on a significant scale.
  • The second issue is that resorting to the ESM might not even reduce the funding costs of many countries. At current yields, and taking into account the minimum fees charged by the ESM, an ESM loan could be financially beneficial only for Greece (given its yield stands at 2.4% at the time of writing), Cyprus (1.6%), Italy (1.5%) and, maybe, Portugal (0.9%) and Spain (0.7%).
  • The third, and probably the most important problem, is that the mere mention of the ESM, of an MoU or of conditionality (which are both requested in an ECCL and thus probably in a PCS credit line) is politically toxic in most of these countries.

How did countries react?

Dutch Finance Minister Wopke Hoekstra described the agreement as “reasonable,” but reiterated his country’s opposition to so-called “Eurobonds” or “Coronabonds” — jointly-issued debt that is being considered as a financial instrument to respond to the pandemic. France, Italy, Spain, and six other EU countries would prefer these as it would show solidarity among the EU nations and keep the worst-affected countries from being drowned by new debt.

Using the ESM option, on the other hand, means that countries like Italy will add to their debt burden. Italian Prime Minister Giuseppe Conte criticized it, calling cheap loans from the EU’s bailout fund a “totally inadequate tool.” He also said that Italy had no intention of applying for such a loan.

Yet German politician Jürgen Hardt expects Italy will take advantage of the ESM, despite Conte’s initial rejection. “I think it was maybe an emotional decision not to use the 39 billion euros reserved for Italy,” he told me. 

Europe’s southern nations “are the ones that need to borrow most, but they’re in the worst position to do so,” Simon Tilford, director of research and management at economics think tank New Forum, told me. “That’s why people are worried about whether this crisis can lead to a break in the eurozone or even member states being forced out.”

The creation of Eurobonds – or resorting to the European Stability Mechanism –  is no substitute for other obligations and implications that cannot be ignored. 

Firstly, both bonds or ESM, are related to the effective economic and financial governance in the  Eurozone. There is the need for a common fiscal and budgetary policy alignment to connect, coordinate, and support unitary work, instead of divisions, in Eurozone countries. Moreover, there is the risk of disruption of the budget of a country during the derogation of the desired financial interventions of Stability and due to Growth Pact regulation. Italy could be the perfect example of this situation as there were rigorous reforms in terms of interests starting with welfare and pensions provoking big concerns for future generations. With that being said, it is possible to understand the direct need for political cohesion, public spending, and solidarity.     

Thursday, April the 23th the EU council approved the creation of a fund for economic restoration called “Recovery fund” meant for the most affected countries and for the most affected economic sectors. Every aspect of the crisis was deeply analyzed and a series of tools able to give the best improvement in post Coronavirus scenario were authorized to proceed. The proposal is up to the challenge we’re facing. The EU Council approved again the reinforcement of EIB, a ‘light’ ESM, and the SURE project which already on their own can implement the Eurozone’s situation.  Their activation is set for June the 1st with an amount of € 540 billion in total.

At the moment, the situation regarding the source and the nature of the bonds, specifically whether they will be subsidies or loans, is not yet well defined.

The single countries are independently debating waiting for further directives and information from the European Council. 

Despite any decision that will be taken, it is fundamental to make the states work commonly, let them cooperate and support each other as also Mauro Magatti, sociologist and economist,  wrote back in February on the newspaper “Avvenire”: “Today Europe is standing at a crossroads. It can either bravely embark on the path of greater integration, thus paving the way for its own future (through, but far beyond, Reconstruction Bonds) or it will disintegrate in the grips of its own internal selfishness. In the delusional belief, ever re-emerging in the course of history, that the strong can be saved at the expense of the weak.”

Sources:

https://www.bbc.com/news/business-19870747 By Andrew Walker, BBC World Service Economics correspondent

https://www.esm.europa.eu/assistance/lending-toolkit

https://www.europarl.europa.eu/RegData/etudes/BRIE/2014/497755/IPOL-ECON_NT(2014)497755_EN.pdf

https://www.consilium.europa.eu/it/press/press-releases/2020/04/09/report-on-the-comprehensive-economic-policy-response-to-the-covid-19-pandemic/

https://www.vox.com/world/2020/4/21/21228578/coronavirus-europe-eu-economic-crisis-eurozone-debt

https://www.esmmagazine.com/retail/covid-19-stay-informed-esm-european-supermarket-magazine-96475

https://www.bruegel.org/2020/03/esm-credit-lines-corona-bonds-euro-area-treasury-one-off-joint-expenditures-what-are-the-options-for-the-eu-council/

https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/eurobond/

A post by Diletta Graziosi & Carolina Busko

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