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Euro-Zone Rescue Talks Are Irrelevant

Ferdinando Giugliano

(Bloomberg Opinion) -- The Covid-19 epidemic has forced the euro zone’s finance ministers to think of innovative ways to combat an inevitable recession. They met this week to discuss how to use the European Stability Mechanism, the single-currency area’s rescue fund, to help countries fund a large-scale fiscal stimulus.

Yet this debate appears largely irrelevant, at least for the moment. The European Central Bank has already launched a 750 billion-euro ($810 billion) asset-purchase scheme that will provide a meaningful safety net for euro-zone governments as they boost spending and increase their deficits. The ECB said its commitment to the euro has “no limits.” This is more important than any credit line coming from the rescue fund.

The case for ESM intervention rests on the idea that countries have vastly different amounts of financial firepower to deal with the economic crisis. Italy’s government debt stands at a towering 135% of gross domestic product, more than twice the ratio in Germany. Giuseppe Conte, Italy’s prime minister, said in an interview with the Financial Times that he’d like the ESM to lend money to all countries in the euro zone. Unlike past ESM rescues, which were conditional on signing up to a program of austerity and structural reforms, Rome believes this one should come without any strings attached.

On Tuesday, finance ministers inched toward giving the Italians what they want. There appeared to be “very broad support” for the idea that countries could borrow up to 2% of their gross domestic product from the ESM. There was, however, a lack of clarity over what conditions (if any) the rescue fund would demand in return. The terms of these loans, including their duration and interest rate, are also unclear. Some more hawkish governments, including the Netherlands, appear very reluctant to offer overly generous conditions.

For all their heat, these discussions look like a relic of the past. An ESM credit line might be a useful addition to the toolkit of any finance ministry, but only if it’s remarkably generous. The ECB is already ensuring countries can borrow at a very reasonable rate, as demonstrated by this week’s auction of Spanish government debt. As my colleague Marcus Ashworth noted, Madrid raised 10 billion euros in seven-year debt, paying only the slightest extra premium to investors even though it’s battling an ever-more-deadly outbreak. So long as the ECB continues to exercise its calming presence, the only advantage of an ESM credit line would be slightly better funding terms.

Even then, the rescue fund’s intervention wouldn’t solve the long-term problem of debt sustainability. Countries will exit the Covid-19 crisis with much higher sovereign debt levels. For member states with weaker public finances — such as Spain and Italy — this will be especially problematic.

And this will be an issue for the euro zone as a whole. It will reduce the ECB’s scope to raise interest rates, since that may make it harder for vulnerable countries to refinance their debt. ESM loans don’t address this problem, since they’d still have to be repaid. Again, only the most generous of terms (a zero coupon, for example) would make a noticeable difference.

The rescue fund still has a useful role to play: as the ultimate backstop. The ECB intervention has been effective, but it may not be in the future if the virus impact worsens. Investors could turn against a country in spite of quantitative easing. In that event, the government concerned will need emergency help from the ESM. That would allow the ECB to purchase unlimited amounts of the country’s short-term debt, through the “Outright Monetary Transactions” program — the official embodiment of former ECB President Mario Draghi’s pledge to do “whatever it takes” to save the euro.

The euro zone should ensure that this help — where it’s truly needed — is offered swiftly and with minimal conditions. After all, no country can be seen as culpable for a pandemic. 

Euro-zone finance ministers also need to wrestle with that question about what will happen as countries emerge from the crisis saddled with huge debts. The debate right now over the introduction of a common debt instrument for the bloc (“Eurobonds”) is unrealistic. It would demand the creation of a euro-zone treasury and the introduction of politically sensitive checks and balances on how each country spends their money — all at the height of a pandemic. But in the near future, the bloc should try to find ways to mutualize at least some of this extra debt, moving decisively in the direction of a “fiscal union.” This commitment could be made now.

The single-currency area lacks the tools to organize a fully federal response to the crisis. Luckily, the ECB is offering a valid alternative. Ministers should be grateful to their central bank — and plan ahead for the next stages of the crisis.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

For more articles like this, please visit us at bloomberg.com/opinion

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