Eurobonds Are Again Coming into Fashion
Ralitsa Kovacheva, 23 May 2012
Somewhat surprisingly the eurobonds emerged as a central topic on the agenda of the informal (in the form of a working dinner) EU summit on May 23rd. Surprisingly because the official topic of the summit are growth measures and employment. But leading international media are blaring forth that it is expected France and Germany to cross swords on the eurobonds issue. And the reason for such expectation are the words of Francois Hollande, the new French president, at the G8 summit in Camp David that on Wednesday in Brussels he will make a proposal for eurobonds. Before analysing why the Franco-German clash on the issue is expected with such anxiety, I will recall how did the idea arise and what is on the table at the moment.
What are the Eurobonds?
In the end of 2010 Jean-Claude Juncker, premier of Luxembourg and Eurogroup president, and Giulio Tremonti, the then minister of finance of Italy, proposed a European Debt Agency to be created to issue eurobonds, worth 40% of EU GDP. The idea was welcomed by the Socialists and the Greens in the European Parliament, as well as by the Liberals, whose leader Guy Verhofstadt is one of its staunchest supporters even today. Because of Germany's resistance, mainly, the eurobonds were mentioned in wishful resolutions of the European Parliament. Until, during the long and tough negotiations on the economic governance package of the EU, the MEPs forced the Commission to promise that it would come up with a proposal on Eurobonds.
As a result, in November 2011 the Commission published a Green Paper, in which it presents three options for the creation of common bonds in the euro area, called Stability Bonds. The three options suggest a various degree of sharing of debt, risk and benefits - from full substitution of the national debt issuance with Stability Bonds with joint guarantees (which goes through amendments of the European treaties), through partial debt substitution with eurobonds and taking joint guarantees (this option is the best for now) to the easiest but the most ineffective option - partial substitution of national issuance with common bonds with proportionate guarantees by the eurozone members. The Commission explicitly underscores that whichever option is to be chosen, it "would have to be accompanied by a substantially reinforced fiscal surveillance and policy coordination as an essential counterpart, so as to avoid moral hazard". And the risk comes from the fact that without the pressure of the financial markets countries will get calmer and will again loosen the ends of public finances and will delay the implementation of reforms.
In the meantime, the German Council of Economic Experts proposed the creation of a common European redemption fund. The idea behind it is debt of countries that exceeds the ceiling of 60% to be merged in a fund with joint guarantees that will be able to issue practically risk-free bonds. Each country that decides to take advantage of the services of the fund will have to sign consolidation programme and to commit to buy back its debt within 20-25 years. In addition, the countries will have to raise a concrete national tax (VAT and/or income tax) and to pay additional revenues directly to the fund. It is explicitly mentioned that the fund must be a temporary tool (including because of the German Constitution) that would provide countries with time to implement the necessary consolidation and reforms without being subjected to extreme market pressures.
This option, which is a variety of the second option as proposed by the Commission, has met significant support in the European Parliament. In order to adopt the increased powers of the Commission in terms of budgetary surveillance in the euro area, the MEPs faced the Commission with an ultimatum to present "a concrete roadmap for the implementation of stability bonds along the Commission green Paper […] and the immediate establishment of a [debt] Redemption Fund".
For and against Eurobonds
As early as they presented their idea a year an a half ago, Juncker and Tremonti said that (partial) merging of debt in the eurozone would impose market discipline to the government without exposing them to speculative attacks, whule in the same time stimulating the European financial and economic integration. Guy Verhofstadt added that the creation of a common bond market for euro debt would weaken the pressure on those in whose liquidity there are serious doubts and everyone would take benefit from lower interest rates. It is no accident that the idea is supported by the peripheral economies, who are subjected to strong market pressure and cannot afford higher rates. But Germany dislikes the idea and this is practically the only eurozone country, perceived by investors as a safe haven.
In this sense, when it is said that the interest rates for some countries would decline to the account of increased interest rates for others, this would be mainly at Germany's expense. This means that Berlin, which is the biggest donor in the rescue fund anyway, will take greater financial burden. Except financial, the German position against debt sharing in the euro area has a legal element too - the country's Constitution forbids the transfer of more powers from Berlin to Brussels. There is a third element in the German position, which is result of the dominating economic thought in the country, and it is that the weakening of the market pressure will cease the reforms process in the troubled countries. This is why Germany insisted on strict rules for budget discipline and control over countries' budget and economic policies by Brussels.
What has changed?
Until now the issue of eurobonds has never been discussed seriously at EU summits, dominated entirely by the Merkozy tandem. Nicolas Sarkozy, the previous French president, supported Angela Merkel's position that merging of debt could not be discussed before the needed guarantees are on the table that the countries would lead sound and coordinated financial and economic policies. But such guarantees are already available with the adoption of the economic governance package, the new powers of the Commission and the signing of the fiscal compact, the ratification of which is underway. This is one argument less in support of the German position.
Not only that Germany has an argument less but it also has one ally less. It is quite logical the new French president, Francois Hollande, to support his fellow socialists in terms of eurobonds and even more logical it is that he will try to make impression at his first European Council. At this stage, aside from his support in principle for the idea, we do not know any details on how exactly does Mr Hollande imagine the creation of common bonds. The European Commission has not yet presented the outcome of the consultations on the Green Paper, so we do not know whether there will be a preferred option, nor what will the next steps on the issue be. In this regard it is interesting to know why Francois Hollande is risking to spoil Angela Merkel's appetite, since he has nothing concrete to offer.
But there is another change and it is in the international context - institutions like the International Monetary Fund (IMF) and the Organisation for Economic Cooperation and Development (OECD) also spoke in support of eurobonds and at the G8 summit similar positions were expressed by USA and Britain. In the eurozone Francois Hollande meets the support of Italian PM Mario Monti, who is considered to be the third apex of the triangle of power in the euro area. Understandably, the idea is to the liking of all troubled countries and as understandably it is disliked by the Netherlands, Austria and Finland.
Given that the informal summit does not aim to take any decisions but only to exchange views, it is obvious that Hollande will use it to feel the grounds and to win political dividends, launching the idea of solidarity, embodied in eurobonds. But the objective of the summit is to comment specific ideas to boost growth and employment, which to turn into specific decisions to be adopted by the European Council in end-June. If the leaders squander their time discussing, may be an attractive but at this stage unrealistic idea for eurobonds, they risk again to be blamed, which will be quite justified, that they ignore economic growth. And this is the last thing they need, while trying to impress the financial markets.