The European Union is facing one of its biggest challenges ever. Due to the impacts of the COVID-19 crisis, the euro area is set for one of its deepest downturns yet – with forecasts predicting a 10% drop in the eurozone GDP this year. Negotiations on the EU’s fiscal response to the epidemic have exposed divisions between north and south and reignited talks about shared debt issued and backed by Europe as a whole.
This idea is not new. It traces its roots to the initiative of Eurobonds, a financial instrument proposed by the European Commission in 2011 in the wake of the debt crisis that then hit several countries in the eurozone. At that time, countries like Italy, Greece or Spain had lost the confidence of creditors due to their bad economic situation and were consequently forced to offer their public debt bonds with very high-interest rates. Eurobonds emerged as a proposal in which the entire eurozone would go to the debt markets. In essence, being backed by the eurozone, Eurobonds would offer greater guarantees than national bonds, thus, making their interests lower and the debt payment cheaper. Although different types of Eurobonds were proposed, none found the support of countries such as Germany and the Netherlands. The main obstacle to the agreement was the disparity between the risk premiums of the different countries, which measures investor confidence in the risk of default; a higher risk premium indicates distrust in the markets and translates into a higher interest and higher cost of borrowing. As such, adopting Eurobonds meant that those countries with a low-risk premium would have to pay more interest on their debt than is usually offered.
The Eurobonds proposal has come back in the context of the coronavirus crisis. Issued once and collectively, so-called corona bonds would drive down the borrowing costs of some of Europe’s most heavily affected countries, preventing another sovereign debt crisis and freeing up resources to invest in public health and economic recovery. The funds would be mutualised and supplied by the European Investment Bank, with the debt taken collectively by all member states of the European Union. These would envisage a one-off issuance to pay for specific aims like health capacity or wage subsidies but would not target the mutualisation of old debt. The nine countries calling for such measures are Spain, Italy, France, Belgium, Luxembourg, Ireland, Portugal, Greece and Slovenia. The main advantage of corona bonds is that they would allow European countries to gain essential financial support. States could receive economic aid without expanding their national debt, thus, relieving countries with already high debt-to-GDP ratios. Furthermore, in the best-case scenario that EU member states were able to show a display of unity, the measure would likely strengthen confidence amongst Europe and would allow the continent to respond to the pandemic jointly. Whether this is something that could work in practice, however, remains to be seen.
Corona bonds bring along much uncertainty and EU finance ministers have until now failed to reach agreement on the issue. The problem is that, while all countries in the EU have been affected by the pandemic, responses have been very different, and so each country’s rates of success. Arguably, some countries such as Spain or Italy, because of the fiscal position they had when they went into the crisis, have been more hesitant to respond than others. Corona bonds would, therefore, ensure that hardest-hit countries are not constrained by their pre-existing financial weakness in their responses to COVID-19. But this comes at a risk for economically stronger countries. The discussion is tense with similar reservations towards Eurobonds as there were in the 2011 crisis. The main argument used against this form of shared debt –backed by “Frugal Four” Germany, Netherlands, Austria and Finland– is that the issuance of these bonds would punish the countries that have managed their economies to act against such difficulties while encouraging further fiscal mismanagement in other countries that have not done so. Essentially, there is the perception that the bonds will promote moral hazard. Supporters of corona bonds argue that the situation is different from that of 2011 since the indebtedness that each State may incur to respond to the pandemic is not a consequence of its economic policy, but of an external factor: a virus.
The heat of the debate has been lowered to some extent thanks to the European Central Bank (ECB) and its Pandemic Emergency Purchase Programme (PEPP), an asset-purchase plan worth €750 billion. The ECB has also relaxed the rules over the debt that they can buy and is planning on spending more than €1 trillion in private and public debt bonds buying until the end of 2020 to keep the eurozone in good financial conditions. Christine Lagarde, the ECB’s president, has stated there were “no limits” to its commitment but has urged governments to consider the issuance of corona bonds. ECB measures will not suffice, and EU governments need to take action. After two teleconferences, the Eurogroup (the finance ministers of the 19 countries that use the euro) agreed on some measures to alleviate the costs of the pandemic on April 9th. These include a €200bn European Investment Bank programme and a €100bn fund from which governments can borrow to support unemployment benefits and salaries. Furthermore, for medical expenses, countries can unconditionally borrow up to 2% of their GDP from the European Stability Mechanism (ESM), a pre-existing bailout fund set up during the euro crisis of 2010-12. Unfortunately, many have pointed out that these efforts will not be adequate to meet the scale of the challenge.
The discussion of corona bonds is a complicated one, so it is difficult to predict its outcome. Countries’ division on the topic has reignited some long-standing debates about how economically integrated the EU really is, engendering discussions about EU solidarity. In the end, this crisis only adds to the long-existing debate between the sovereignty of the individual member states and the overarching power that is given to the European Union – a discussion that is far from being resolved.