Corona Bonds Would Pave the Way for a Comprehensive Bailout by EU Taxpayers
Questions & AnswersInterview with ZEW Economist Friedrich Heinemann
The COVID-19 pandemic has shaken economies around the world. While the German Bundestag has adopted a rescue package that will be financed through deficit spending, other eurozone states, such as Italy and Spain, have less room for financial manoeuvre due to high existing debt levels. Accordingly, Italy and Spain have been leading calls for the introduction of ‘corona bonds’.
In this Q&A, ZEW public-finance expert Friedrich Heinemann, explains why corona bonds are not the right tool in the current crisis.
What are corona bonds exactly?
A large number of corona-bond models have been proposed, as was the case ten years ago in the debate surrounding eurobonds. These models all have one thing in common, however: They envision the EU or eurozone countries collectively issuing bonds for which all Member States would accept joint and several liability. This liability would be more extensive than that associated with ESM or ECB loans. Member States are only partially liable for assistance provided through the ESM; no single state is responsible for the full amount. Furthermore, liability on government bonds purchased within the eurosystem is limited by the fact that only national central banks purchase their country’s bonds. By contrast, the corona bond would introduce collective liability for the public debt of Member States – a form of liability that does not yet exist in Europe.
What would an introduction of corona bonds mean for a country like Italy?
Italy, like all the other euro countries, is experiencing an unparalleled shock because of the coronavirus crisis, which is now rapidly pushing up public debt. In contrast to most euro states, however, the country has already entered the crisis with a debt level as high as 136 per cent and low growth potential, so that even before there were doubts about its debt sustainability. It is likely that COVID-19 will put Italy into a situation of insolvency. The country will then no longer be able to service its debt from its own resources. Corona bonds would provide relief: Interest rates would remain low despite a poorer credit rating, and in the event of a default, the other EU states would come to the rescue by assuming joint liability.
What effects could corona bonds have on the eurozone?
Corona bonds were proposed as a means of financing the fiscal costs of combating COVID-19. Whether their use would actually be restricted to this purpose is questionable, however. If corona bonds were introduced, this would further depress the willingness of investors to purchase the debt of countries potentially at risk of default. A vicious circle could develop in which countries such as Italy become dependent on fresh capital injections from the EU to repay maturing national debt obligations. But the broader question, typically left undiscussed, is as follows: How should Europe handle unsustainable debt levels in Member States? In essence, corona bonds would solve the problem of unsustainable debt through redistribution, by transferring this debt to solvent Member States. Establishing corona bonds would thus mean paving the way for a comprehensive bailout by EU taxpayers, particularly those in wealthier nations.
Is there another option for stabilising highly indebted countries during the crisis?
During this immediate phase of the crisis it is essential to provide highly indebted countries with a large volume of liquidity, without imposing strict conditions. A chaotic default on the part of eurozone states would be a disastrous event given that we are standing at the doorstep of the most severe recession in EU history. The ESM should be the tool of first choice for providing needed liquidity. The ESM is an effective and proven tool. It also features clear rules and a veto mechanism to protect Member States from one-sided deals. Past experience with extending assistance to Ireland, Portugal and Spain has demonstrated that it can be deployed on a temporary basis, without becoming a permanent life support system. Only Greece is still dependent on liquidity infusions from the ESM; however, there are strict conditions attached this assistance. Countries that draw on the ESM know that they can count on help for one or two years, but that long-term support will entail considerable limitations to their national sovereignty.
How should we address unsustainable debt in eurozone states from a long-term perspective?
This is perhaps the most difficult question that Europe will face in the coming years. There are essentially three options: first, solvent states can foot the bill by providing a bailout; second, creditors can be forced to take a haircut; and third, a special tax can be levied on particularly wealthy groups in the insolvent nation. These options could also be employed in combination. However, none is without significant risks, whether political or economic. Given the current environment of uncertainty, it would be virtually impossible at present to arrive at a balanced, rational and well-informed decision concerning how to restructure sovereign debt. Accordingly, our aim should be to simply buy time and delay negotiating a deal on this difficult issue until the pandemic has subsided and markets are calm. By contrast, the establishment of corona bonds would constitute a fait accompli that would almost inevitably culminate in a bailout funded through redistribution from less indebted states.