EU: The Debt Mutualization Wars

Published on April 9, 2020

After a marathon – even by European Union standards – 16-hour slug fest, EU ministers finally agreed today on the three-pronged, (ESM, EIB, and “Kurzarbeit-styled” employment scheme), 590 billion euro credit line stimulus plan that we first flagged last week (see SGH 4/2/2020, “EU: A Three-pronged Fiscal Package”).

** That battle, however, was really a proxy for a far bigger war, with far greater long-term political consequences for the EU and Eurozone, over a “Corona-bond” debt mutualization proposal spearheaded by France’s Finance Minister Bruno Le Maire to ride this crisis, if ever there is a time, to establish an historic, joint debt issuance instrument for the EU.

** Italy, Spain, and six other countries have joined the French proposal to establish a fund of around 3% of EU GDP, or about 420 billion euros, to be financed through joint borrowing of all EU governments on the market. That should ensure (in theory) that the debt has a triple-A rating, which would in effect translate into an around 0% cost, and afford countries like Italy, now borrowing at around 1.6% over ten years, considerable savings.

That is not going to happen.

** Germany’s Chancellor Angela Merkel reiterated today that Berlin would not agree to a joint issuance of debt, and in that she is joined, in no uncertain terms, by the Netherlands, Austria, and Finland. However, there is a soft alternative, from what we understand, that is just starting to be bandied about behind the scenes – even if, for now, it is still a long-shot.

** The idea that could emerge – and this, again, is very preliminary – would be to use the next long-term EU budget, formally known as the Multi-annual Financial Framework (MFF), which is already a collective affair, as the basis for a new debt instrument.

** For this to work, all EU countries (not just the Eurozone subset) would need to agree as proposed by EU Budget Commissioner Johannes Hahn to increase the maximum financing ceiling for the next EU budget for the 2021-2027 term to say 2% of EU GDP (or 240 billion euros annually), as opposed to the currently proposed 1.2% of GDP.

** This would allow the European Commission to borrow an estimated 100 billion euros annually against the security of the higher budget number on the market, and then leverage that by a factor of 10:1 against its triple-A rating to provide investment funds for member states.

** Whether or not this will fly is for now anyone’s guess, but the concept of using a scaled up MFF to finance a recovery is being increasingly mooted in private between EU officials, although we suspect any technical details, far less political consensus, is still far from clear.

It is a space worth watching.

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