We need a new balance

The path to a common European solution for refinancing the Corona crisis is still a long one. This was shown by the video conference of EU heads of state and government last week (an overview of the main results is given below).

The states often go to the limits of what is financially feasible with their current rescue concepts and measures. Countries such as the USA or Germany can certainly afford this so far without having to worry about sustainable financial stability. But even in these countries it is not possible to continue with this unlimited financial willingness to help in the long term.

An economy needs sustainable growth and prospects. At least one, or better both, components are necessary for business start-ups and investments. In the coming weeks, policymakers will have to pay more attention to economic issues and, if necessary, change their weighting in weighing up risks. A prolonged recession will certainly have very serious consequences for society, which will have to be weighed up. If the number of infections rises again, this should not immediately lead to another lockdown, as the economic consequences would be very negative. Rather, it is now more important to prepare the opening in a technically and organisationally reliable way.

Surely all this is not an easy decision. But without the prospect of a rapid, effective vaccine, society and politics must now learn to live with the corona virus. This requires a new balance in weighing up the risks for risk groups and for overall social development and its social consequences. This new balance should be balanced in such a way that it opens up new perspectives.

Results of the EU Heads of State and Government

The European Council yesterday effectively put the idea of corona bonds on the back burner. In the end, only Italy had vehemently called for them, while the core states for the most part stuck to their no‘ vote and more and more peripheral states showed themselves willing to compromise and support alternative solutions. Officially the idea is not buried, but Italy will probably have a hard time pushing through corona or Eurobonds if it fails to do so even at the height of the corona pandemic. For Italian Prime Minister Conte, this also means a serious domestic political defeat, because he declared himself to be the biggest supporter of corona bonds and, above all, the ruling five-star movement and the opposition had demanded them. He may now be suffering from the political stigma of not having succeeded despite the initial support of France. Conte is likely to be called upon to achieve early successes if the already fragile peace of the coalition in Rome is not to be jeopardised in the greatest crisis since the Second World War.

The countable decisions of yesterday’s summit are limited to the package of measures amounting to 540 billion euros, on which the Eurogroup had already agreed before the conference. This provides for a triad of measures, which includes ESM loans for states of up to 240 billion euros, EIB loans for small and medium-sized enterprises of up to 200 billion euros and 100 billion euros in funds for SURE (new EU programme for short-time working allowance). While this package of measures was hailed by those involved as proof of European solidarity, given the scale of the current crisis it is only a little more than the proverbial drop in the ocean. The second problem is that in Italy there is still a dispute about whether the country should accept ESM aid at all. From Italy’s point of view, the ESM has the stigma of being an aid fund for countries that have slipped into an asymmetrical economic crisis. The Corona crisis is hitting Italy like a natural disaster, but without fault. As the coalition parties PD and Viva Italia are in favour of ESM loans for pragmatic reasons, Italy has not yet taken a final position on this issue.

The European Council is aware of the need to adopt more far-reaching measures. It has therefore asked the EU Commission to develop the idea of a reconstruction fund or Marshall Plan into a concrete proposal. This could be hung up under the EU umbrella, as the use of existing European institutions saves time. The alternative of expanding the ESM is not the preferred option in view of Italy’s reservations. The main difference between the Reconstruction Fund and corona bonds: corona bonds would have led to joint and several liability of all states. Germany, France and the Netherlands would ultimately have been liable for all bonds if other countries had defaulted. In addition to the financial risks, this would also have caused legal problems, such as Germany’s argumentation. In the case of the reconstruction fund, however, the states are liable only to the limited extent of their capital contribution and an agreed guarantee framework, which could be based, for example, on the share of GDP in the eurozone.

Yesterday, the Council was unable (yet) to answer two key questions: a) How large should the fund be and b) does it only grant loans or does it also provide grants. With regard to its size, expectations are that it will be around EUR 1 trillion, so that the total amount of EU aid would be around EUR 1.5 trillion (ESM, EIB, SURE, aid fund). This would correspond to just under 15% of the eurozone’s annual economic output. Whether the sum can be considered high will depend on the period over which it is ultimately to be distributed. When it comes to the question „loans or grants?“ the line of interest runs between North and South and West and East. Many northerners shy away from „giving away“ money to the South (also for domestic political reasons). The eastern EU states are driven by the concern that corona aid will lead to a diversion of existing subsidies, from which they have so far benefited most.

As expected, impatience is growing among investors. The market is also concerned about how Italy will be able to cope with a rise in the debt ratio if the grants are limited. Italy itself expects a budget deficit of more than 10% of GDP this year. The debt ratio could rise to over 150% within a year. Not surprisingly, risk premiums on peripheral government bonds rose this morning – BTP Bund spreads widened by around 10 basis points.

Moody’s is currently building up less pressure vis-à-vis Italy. The agency, which currently gives Italy its worst rating of Baa3 (stable), has signalled that it sees no reason to downgrade the country to non-investment grade at present, partly because of the country’s low refinancing costs. However, Moody’s has linked this assessment to the condition that a) the economy starts to grow again from Q3 onwards, b) refinancing conditions remain favourable and c) Italy presents plans to reduce its debt again after the crisis. Moody’s is thus granting Italy a deadline in the crisis, but the expectations it has formulated nevertheless highlight the seriousness of the situation and the need for an early European solution.

Conclusion: With their No to Corona Bonds, the EU states have reaffirmed what they do not want to do to overcome the current crisis. However, the scale and serious economic consequences of the crisis mean that a solution acceptable to all will soon be required. There is no time for prolonged tactics.

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