Coronabonds: The answer to Europe’s post-virus economic crisis?

You’ve heard of government bonds, you’ve heard of corporate bonds and you may even have heard of muni bonds, a popular asset class in the United States.

Coming next, possibly, will be coronabonds.

But that all depends on the outcome of a huge debate in the Eurozone which is due to be settled this week.

Governments in countries such as the United States, the United Kingdom and Japan are all going to spend vast sums to navigate their way through this crisis by borrowing – issuing massive amounts of debt in their own currency.

Members of the Eurozone, likewise, can issue debt denominated in the euro. However, as was seen during the Eurozone sovereign debt crisis of 2011-12, the borrowing cost of each Eurozone member can vary dramatically depending on how investors assess the ability of each member to finance their borrowing costs. During that crisis, the yield – a proxy for borrowing costs – on bonds issued by the Greek, Spanish, Portuguese and Italian governments shot up, reflecting an expectation among investors that they might not be able to do so.

Mario Draghi, the then president of the European Central Bank (ECB), rode to the rescue by saying he would do “whatever it takes” – which turned out to be introducing negative interest rates and buying in some €2.6trn worth of Eurozone government bonds (quantitative easing, or QE, in the jargon).

Yet that episode only kicked into the long grass a debate that has continued to nag away at members of the Eurozone ever since: should the Eurozone issue debt on a joint basis?

This is why the idea of ‘coronabonds’ is on the agenda.

Such bonds would be commonly issued by the Eurozone as a whole to fund the huge amount of borrowing required for Eurozone members to navigate their way through the COVID-19 crisis.

The idea was proposed by the leaders of nine Eurozone members – France, Spain, Portugal, Italy, Ireland, Greece, Belgium, Luxembourg and Slovenia – in a letter to Charles Michel, the president of the European Council, on 25 March.

The attraction for countries like Greece and Italy is obvious. Their borrowing costs would be lower because, with the entire Eurozone standing behind their debt obligations, investors would regard them as less likely to default.

For those countries which are renowned for their frugal attitude towards borrowing, such as Austria, Finland, the Netherlands and, of course, Germany, the attraction is less obvious other than as a display of solidarity.

That, alone, is enough for some politicians in more fiscally conservative countries. Nils Schmid, foreign affairs spokesman for the SPD – the junior partners in German Chancellor Angela Merkel’s governing coalition – told the Financial Times that issuing coronabonds would show that “we’ve learned from the Eurozone debt crisis.”

He added: “Then, a lot of countries felt abandoned, and the aftermath of that is still being felt.”

In this photo illustration, the new £10 note is seen alongside euro notes and US dollar bills on October 13, 2017 in Bath, England

Many other governments are all going to spend vast sums to recover after the pandemic

The attitude of Germany, as the Eurozone’s wealthiest and most important member, will determine whether the idea goes ahead. That is why Berlin is being lobbied intensively ahead of a teleconference of the Eurozone’s 19 finance ministers on Tuesday.

The latest lobbying came in the Frankfurter Allgemeine Zeitung, one of Germany’s most influential newspapers, by Thierry Breton and Paolo Gentiloni, respectively the EU’s internal market commissioner and the economy commissioner.

They wrote that the issue of collective debt would be proof of “unshakeable solidarity”.

That appears not to have swayed Mrs Merkel who, according to her chief of staff, continues to be sceptical about the idea.

In the absence of support from the Germans the chances are that, in classic European tradition, some kind of fudge will emerge.

One idea doing the rounds is that debt could be issued by the European Commission through the European Financial Stability Mechanism (EFSM), the vehicle used to bail out Greece, Portugal and Ireland during the Eurozone sovereign debt crisis, which is funded by the EU budget.

Another is that the European Stability Mechanism (ESM), the Eurozone’s bail-out fund, makes credit facilities available to all Eurozone members. This solution is favoured by Germany and has been supported by France.

A third is that the European Investment Bank, another EU-wide body, makes funds available that could be tapped by smaller companies.

And a fourth is the creation of a ‘corona fund’, with a fixed lifespan of five to 10 years, which would provide cheap credit to EU countries. This has been proposed by France and is thought to be tacitly supported by the Dutch provided that it is a one-off fund.

A fifth option, seen as the most likely, would be the creation of an unemployment insurance scheme, funded by the EU budget, in which around €100bn would be made available to EU governments to help those workers who would otherwise lose their jobs during the current crisis.

But coronabonds themselves look too divisive.

As Christopher Dembik, head of macro analysis at Saxo Bank, puts it: “As the Union is not facing a life-or-death crisis, it is likely that coronabonds will be out of the discussion.”

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Lorenzo Codogno, a former chief economist at the Italian Treasury and now visiting professor at the London School of Economics, warns that using the ESM might not be palatable to Italy and some other countries because it might be seen in some quarters as a “Trojan Horse for the Troika [the triumvirate of the IMF, EU and ECB that enforced austerity in countries like Greece after its bail-out]”.

He said: “A good result in my view would be the one in which Eurozone countries agree on a big recovery plan managed by the EIB, the Commission, or any other European institution, financed by joint long-term issuance, i.e. safe assets.”

So, while coronabonds may not be signed off this week, the fact they are even being discussed is important.

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Critics of the Eurozone have long argued the euro is unsustainable without some form of debt-sharing, or ‘debt mutualisation’ in the jargon, whereby German and Dutch taxpayers stand behind the borrowings of their Greek and Italian counterparts.

The Italians were horrified when, last month, Mr Draghi’s successor at the ECB, Christine Lagarde, said it was not her job to bring down Italy’s borrowing costs relative to those of Germany.

The clear implication was that the Italians were on their own.

Much more of that and Rome may well conclude it is indeed better off outside the Eurozone.

And, in the absence of support from elsewhere in the EU or the Eurozone, such a decision might be forced by events.

As Professor Codogno puts it: “At some point, financial markets will test Italy’s resilience and the ECB’s commitment.”