Eurozone member states are debating the highly sensitive question of when and how to bring the region’s powerful economic rescue fund into the fight against the fallout from coronavirus.
Member states are divided over how soon and under what conditions the €500bn European Stability Mechanism could be used to support euro area economies as they grapple with the most serious downturn since the Great Recession of 2007-09, diplomats said.
Officials are examining the ESM’s options, including the idea of offering credit lines to multiple member states. It would be a sharp departure from the ESM’s previous actions, when it targeted individual countries such as Greece at moments of acute market trauma.
“The ESM can do a lot if the willingness is there,” said Karel Lannoo, chief executive of the Centre for European Policy Studies. “It can be made available very rapidly.”
Deploying the ESM in this way could unlock the vast debt-buying firepower of the European Central Bank, creating a powerful tool for fighting the eurozone’s rapidly deteriorating economic situation.
Klaus Regling, ESM managing director, said on Monday night that his institution was ready to examine ways it can help. But Germany and the Netherlands are among the countries which worry that attempting to bring the ESM into play soon could send the wrong signal and further sap investor confidence.
What is the ESM?
The ESM is a crisis-fighting institution that was set up in October 2012, in the thick of the eurozone’s sovereign debt crisis, to provide a permanent backstop for countries that could no longer tap financial markets to raise funding.
Its prime purpose is to be a vehicle for sovereign bailouts. It wields its strong credit rating to raise money on the capital markets, using the funds to provide bailout loans at preferential rates. It currently has €410bn of unused lending capacity.
The ESM is legally separate to the EU, and its shareholders are the eurozone’s 19 national governments.
What role could it play now?
Following Monday’s eurogroup meeting, Mr Regling emphasised that all EU member states still have market access, drawing a distinction with the 2010-15 debt crisis.
But the ESM’s toolkit is much wider than simply bailout loans. It can also provide precautionary credit lines to countries to shore up investor confidence.
One option under discussion is to issue such credit lines to multiple member states, reducing the stigma that would be attached if a single government made a request. Of key concern is the situation in Italy, where yields on government bonds have already risen as coronavirus weighs on its economy and its mammoth sovereign debt load. Yields rise when prices fall.
Separately, on Tuesday night French president Emmanuel Macron suggested to fellow leaders that the ESM could issue joint coronavirus bonds as part of the crisis response. Diplomats said the idea attracted little comment from other eurozone leaders.
Mr Regling has privately mooted the creation of a new rapid financing instrument, akin to a similar tool available to the IMF. This would allow the ESM to quickly provide financial support to countries in need without all the conditions attached to full bailouts.
But diplomats caution that any such step would take time to put in place. This means that the precautionary credit lines are the main initial option.
What are the obstacles?
They are legal, practical and political. Support from the ESM comes with strings attached: governments receiving aid need to sign memoranda of understanding setting out detailed policy commitments to get their countries back on track.
Wielding the ESM also requires buy-in from a number of national parliaments. Even precautionary credit lines come with conditions, notably respect for the bloc’s budget rules.
Italy, for example, would not normally qualify for the standard ESM precautionary credit line because of its high debt-to-GDP ratio. Instead, it would have to seek an enhanced conditions credit line with tougher requirements to mend its public finances.
Some countries worry that involving the ESM too early on could backfire, sending a message to investors that the euro area is in bad shape and drawing attention to a tool that may be needed later.
“Starting a discussion on precautionary credit lines now would be a mistake,” said one senior EU diplomat. “It is something that is not needed at this stage.”
What role could the ECB play?
One of the benefits of using the ESM is that it can unlock the use of the European Central Bank’s hugely powerful Outright Monetary Transactions programme of bond purchases — a weapon that has its genesis in Mario Draghi’s famous “whatever it takes” speech of 2012.
OMT allows the ECB to buy an unlimited amount of a eurozone country’s bonds as part of an official ESM-backed bailout, providing that country’s financing costs are judged by the central bank to have been pushed higher by investors anticipating a eurozone break-up.
Taking an enhanced conditions credit line is a key precondition for a country to unlock OMT.
Even if all conditions were met for its use, it would be up to the ECB alone to decide whether to do so.
OMT has never been used but its creation is widely credited with helping to bring down yields on peripheral EU countries’ government debt, including Italy. It was challenged in the German constitutional court, but in 2015 the European Court of Justice approved it as a legal part of the ECB’s armoury.
Under the precursor to OMT, the Securities Markets Programme, the ECB bought more than €200bn of Greek, Italian, Spanish, Irish and Portuguese bonds. By December, it still owned €48.5bn.
