The right tools for the job
EYP Italy’s companion to the current debate on economic solidarity
In light of the Covid-19 pandemic, Member States have faced major difficulties while trying to stop the spread of the virus in order to prevent their healthcare systems from collapsing.
As a consequence of the governmental measures put into place, the European economies have suffered a huge blow with a recession of historical proportion looming on the horizon. It is clear to everyone that unprecedented economic measures are going to be required to spare the worst consequences of this crisis.
Of course the nature of these measures has been harshly debated in the EU, and included the discussion of topics such as the European Stability Mechanism (ESM), the SURE programme, and the creation of the so-called “Eurobond”.
Before digging into the discussion it is important to understand the concept of public debt, around which most of the debate on the response to the pandemic is focused.
Every State guarantees to its citizens certain financial services like pensions, healthcare, schooling, security, investments and other expenses. They pay them by means of taxes, but in most cases they are not able to provide the total amount needed. The difference is therefore covered by loans with added interests. In exchange, as to assure the payment, there are also some obligations called bonds.
These added interests and bonds depend mainly on the reliability of the country, or at least on the perception the investors have about its economic stability. At a first glance, having a high national debt might seem an indicator of a struggling economy, but it is not totally true: Japan’s national debt amounts to 200.5% of its GDP (Gross Domestic Product), the American one to 106.9%, but their interests rates on bond over the last 10 years are respectively of 0.02% and 0.88%.
On the contrary, Italy has not only has a very high debt (134.8% of its GDP), but also a high interest rate on bonds (1.7%). In fact, many factors influence these countries’ capacities to keep refinancing their public debts, but the size of the economy, who holds most of the debt, and what currency it is issued in are big factors. Despite this, it is extremely important for governments to undergo a steady reduction of such debt in the long term.
This said, we can now understand better the concepts of ESM and eurobond which are tools to create debt in a sustainable way for the economy.
What is the ESM?
The ESM is a programme whose aim is to provide financial assistance to Euro Area Member States(EAMS) that are experiencing a crisis which could endanger the Euro Area as a whole: it was established after the 2010 financial crisis, during which a number of Eurozone countries encountered significant difficulties in placing their bonds on the market: investors simply wouldn’t buy them, and the European Central Bank, following its unique statute, was not acting as a last-resort buyer.
The ESM basically serves as an emergency fund to which all its 19 members (list below) contribute on a proportional basis: Germany is the biggest contributor, as it provides 27% of the quotas, followed by France and Italy, the former contributing for 20%, the latter for 18%. The total “capital subscription” (how much money the ESM can practically raise through the emissions of its bonds) is of € 704.80 billion, although only € 80.55 billion of which are actually bailed in.
It is important to underline that the ESM has six different ways of fulfilling its lending purpose: as of today only two of them have been used by a number of Member States (Ireland, Cyprus, Greece, Portugal and Spain) and some loans were actually disbursed by the European Financial Stability Facility, an institution whose lending role has now been taken by the ESM.
The ESM is capable of offering six different financial aid instruments: each one is designed to disburse loans in a specific situation. These loans come with conditions (officially referred to as “conditionality”) that can vary depending on the amount of loans requested.
It is important to analyse the concept of “conditionality” in order to fully understand the implications of an EAMS’s request of financial aid through the EMS: being this institution outside of the EU legal framework, it is the Commission’s job to negotiate all conditions on its behalf with the applicant Member State.
When (or if) an agreement is reached, the loan is disbursed and regular checks on the respect of the agreements are conducted by the ESM, the Commission, the European Central Bank and the International Monetary Fund (wherever possible).
Conditionality applies to a number of economic sectors, and it aims at consolidating the fiscal health of the applicant by reducing debt to GDP ratio, usually by cutting government expenditure, improving the efficiency of the public administration,tax reform and privatisation. Other reforms are aimed at boosting potential growth and creating jobs and also banking surveillance and recapitalisation, both direct and indirect.
Conditions regarding the disbursement of loans through the EMS are laid out in Regulation 472/2013
What is an eurobond?
The concept of Eurobond is as old as the Euro itself, but was firstly introduced in policy proposals around 2011–2012 during the Greek Debt crisis, which rapidly expanded to Portugal, Ireland, Spain, and, lastly, Italy. At the time, the European Commission (EC), guided by José Manuel Barroso, put this idea into a proposal (the so-called blue bonds), which was not approved by the EU Council.
Specifically, a eurobond is a debt instrument emitted by a EU institution (most proposals assign this power to the European Commission) and which is guaranteed by the EU itself.
Eurobonds are very safe instruments from a financial point of view, since they are guaranteed by what nowadays is the largest economic entity in the world (the EU single market) and denominated in Euros, one of the global “reserve currencies” (alongside the dollar, the Japanese Yen, the British Pound, the Chinese Yuan, and others).
To put it simply, eurobonds would allow Member States to borrow money from markets at low and convenient interests, thus enabling them to go into debt in a more sustainable manner.
What is the SURE programme?
The SURE (Support to mitigate Unemployment Risks in an Emergency) programme has been proposed by the EC and it stands as an instrument aimed at protecting jobs and employees: its “firepower” will be of 100 billion Euro which will be erogated through loans granted by the Commission to Member States
The fund will put together €bn 25.00, which will serve as a guarantee to emit credit.
The EC will borrow on financial markets in order to provide Member States with the best possible interest rate, due to its high profile market trust.
These funds will strengthen the pre-existing state funds aimed at mitigating the effects of the full-lockdown: the whole idea behind this programme is to prevent jobs from being lost, as enterprises are lacking liquidity due to the temporary halt of consumer demand.
The ESM and the Eurobond are different possible tools to tackle the need to support suffering economies and vital institutions like healthcare and education: if the first one has already been used and tested during past crises, the second one, like the SURE programme, has been theorised for a long time, but never used and would be a further step towards a more united Europe.
These totally new challenges require after all innovative solutions never seen before, which will shape the EU’s future and it is important to remember that good choices made at the right time will prove extremely beneficial and will create a better and stronger EU.
written by: Michele Rivetti and Benedetta Stoiculiasa
