Euro-zone policymakers’ plan to offer precautionary credit lines to some governments is a step in the right direction, but it is too small and not the best tool for the job. It stops well short of fully mutualising the cost of dealing with the virus – which may be needed to contain the risk of a new debt crisis.
- Euro-zone policymakers’ plan to offer precautionary credit lines to some governments is a step in the right direction, but it is too small and not the best tool for the job. It stops well short of fully mutualising the cost of dealing with the virus – which may be needed to contain the risk of a new debt crisis.
- Governments have already announced a barrage of policies to limit the economic damage caused by the virus. Table 1 summarises those in the euro-zone’s big four economies. Clearly, these measures won’t do much to raise demand so long as governments keep large parts of the economy closed.
- They will also add to public debt. Chart 1 shows what would happen to debt ratios this year if budget balances deteriorated by 20% of GDP, as we think is plausible, and nominal GDP fell by 5%. For some countries, such as Germany and the Netherlands, the increase in debt would be manageable. But for others, most obviously Italy and Greece, debt burdens would look even more worrying.
- With that in mind, the Eurogroup’s plan to offer precautionary credit lines to governments that request them is helpful, but in our view it is not adequate. Rightly or wrongly, these programmes come with stigma attached, deterring governments from requesting them. And while a programme may open up the possibility of ECB OMTs, those purchases are limited to bonds between 1- and 3-year maturity and are also subject to the issuer limits capping QE purchases. So unless these rules are changed, they aren’t a game changer. What’s more, Eurogroup President Mário Centeno has said that the credit lines would be worth around 2% of the recipient’s GDP, which pales in comparison to the potential cost of this crisis. The ESM’s entire existing lending capacity of €410bn is equivalent to 3.4% of euro-zone GDP, which also looks quite small.
- While a scaled-up version of the ESM’s precautionary credit lines may be sufficient, we think that “corona bonds” would have three key advantages over offering credit lines to individual countries. These bonds could be issued by the ESM, and the funds distributed condition-free to member states that needs them.
- The first benefit is that it would reduce the need for austerity in countries that borrow from the ESM once lockdowns start to be relaxed. It is very unlikely that policymakers would impose budget cuts on countries borrowing from the ESM as long as large parts of their economies are shut down. But Tuesday’s statement by Mr Centeno implied that the ESM programmes would require austerity at some point in the future. Avoiding another period of austerity would mean stronger demand in countries borrowing from the ESM, which would also support demand for core countries’ exports.
- The second benefit is that it would reduce the risk of another debt crisis. If governments had to fund the increase in their deficits entirely through issuing sovereign bonds, investors may demand a higher risk premium due to the likely deterioration in their debt dynamics. And the ECB’s track record suggests that investors would be uncertain whether it will stand behind government bond markets indefinitely.
- The third benefit is that this could be a step towards some form of fiscal union. It would demonstrate that a fiscal union could work without imposing a huge and permanent financial burden on core countries, particularly if the central euro-zone budget was used primarily as a counter-cyclical tool. This could go a long way towards making the euro-zone economy and financial system more stable in the long run.
- To reap the full benefits, corona bonds would need to be issued on a large enough scale to cover most of the cost of this crisis, which will be a minimum of €1trn (8.4% of GDP) or more. If issued by the ESM, that would triple the size of the fund. But this possibility still seems to be on the table. Christine Lagarde reportedly supports corona bonds, and nine euro-zone leaders – including Emmanuel Macron and Giuseppe Conte – have signed a joint letter calling for them to be issued, which will presumably be discussed at the EU leaders’ meeting later today. While some governments are still against the proposal, most notably Germany, that could soon change if the situation continues to worsen.
Fiscal Measures (numbers in brackets are % of GDP)
Loans/other measures (numbers in brackets are % of GDP)
Total extra borrowing of €156bn (4.7%), including:
Support for households and firms (1.5%);
Lower tax revenue (1.0%);
Loan guarantees worth up to €822bn.
Establish fund worth €500bn (14.5%) to buy the equity and debt of firms struggling due to the virus.
€100bn (2.9%) loan to KfW, to be lent on to firms.
Total fiscal measures of €45bn (1.9%), including:
Deferred tax and social contribution payments due
Support for household income and very small firms (0.3%);
Improved sick pay and remuneration of healthcare workers (0.1%).
€300bn (12.4%) in guarantees on all new loans that firms request from their banks.
State investment bank Bpifrance offering direct unsecured
Total fiscal measures of €25bn including:
Support for household income and spending (€10.2bn);
Additional healthcare spending (€3.2bn);
Tax payment suspensions and extra tax credit (€1.6bn).
Repayment moratorium on loans to SMEs worth €220bn (12.3%).
Guarantees on loans to SMEs worth €100bn (5.6%).
€17bn to “help the groups most likely to suffer from the
Deferrals of payments of taxes and social contributions (€2.8bn);
Moratorium on mortgage payments and utility bills.
€100bn (8%) in state-backed credit guarantees for companies.
Source: Capital Economics
Chart 1: Government Debt (2020, % of GDP)
Source: Capital Economics
Jack Allen-Reynolds, Senior Europe Economist, firstname.lastname@example.org