Corona Bonds Are the Wrong Instrument
CommentZEW Economists Achim Wambach and Friedrich Heinemann on Corona Bonds
In a recently published opinion piece, ZEW President Professor Achim Wambach and Professor Friedrich Heinemann, head of the ZEW Research Department “Corporate Taxation and Public Finance”, argue in favour of using the European Stability Mechanism as an instrument of financial assistance instead of corona bonds. In their view, corona bonds are difficult to implement, their underlying concept would not meet the desired needs and they would currently do more harm than good to Europe.
The Eurogroup remains divided about which instruments are the best “line of defence” against the economic effects of the coronavirus pandemic. It seems to be undisputed that additional funds from the European Investment Bank should be unlocked to provide loans to companies. A new instrument to strengthen short-time work schemes in Europe suggested by EU Commission President Ursula von der Leyen is also met with great approval. Eurozone members are, however, split over the new European debt instruments.
Nine government leaders, including from France, Italy and Spain, have been calling for jointly issued corona bonds to support those euro countries that are hardest-hit by the crisis. Economists proposed that bonds worth one trillion euros – about eight per cent of the euro countries’ gross domestic product – be issued. Other European countries, including Germany, the Netherlands and Austria, are opposed to this proposal and instead champion the idea of activating the ESM’s precautionary credit line, which individual countries can draw on if necessary. Among other things, they have pointed out that it would take too long to introduce corona bonds. This argument may even miss the key concern. The main problem with corona bonds is not just the difficulty of their implementation. More importantly, their underlying concept is flawed, this innovation would not meet the desired needs, and the new bonds would currently do more harm than good to Europe.
Corona bonds may impair credit ratings
Undoubtedly, the “line of defence” against the economic effects of the pandemic must ensure that countries have sufficient resources during the coronavirus crisis. They could otherwise be forced to renounce stabilization and stimulus measures that are actually useful, with negative economic consequences for Europe as a whole. Corona bonds promise to be a short-term remedy, but could lead to the situation worsening in the medium term. This is illustrated by the example of Italy.
At the end of 2019, Italy’s public debt stood at 2.4 trillion euros, and it is very likely that it will soon exceed 2.5 trillion euros. Since part of the national bonds are constantly expiring and have to be renewed, Italy will have to borrow over 350 billion euros in 2020. If assistance is distributed based on the ECB capital key, as has been proposed, Italy’s debt share would amount to 130 billion euros in case of a one-off European corona bond issue of one trillion euros. And if Italy were to receive an additional net transfer in the amount of 100 billion euros beyond its debt share, the country would only be able to pay down four per cent of its existing stock of debt.
It is therefore unlikely that such a corona bond would significantly improve Italy’s creditworthiness. On the contrary, Italy could even face a lower credit rating. At the latest once the funds from the first corona bond issue have been used up, Italy must return to the capital market. Considering that corona bonds are senior in priority to other budget obligations, this would lead to even higher risk premiums for conventional Italian bonds on the capital markets. In addition, the issue of corona bonds can be a signal to investors that the marketability of national bonds may be at risk in the future.
ESM offers advantage of established procedures
Drawing on loans from the ESM’s precautionary credit line would have a similar effect on the capital market capacity of the supported country, since the ESM’s claims against the debtor countries explicitly enjoy priority over those of other creditors. However, it would not be mandatory to draw on these funds. The ESM offers the additional advantage of having established procedures that have been in place since 2012. Moreover, it is still available should further stabilization measures become necessary at a later stage.
In the case of corona bonds, the question also arises as to who should receive the funds and according to which criteria. European solidarity rests on the principle of mutual assistance in times of need, meaning that countries less affected by the crisis should assist countries that are more heavily affected. But what’s the definition of ‘being heavily affected’? At the moment, we are mainly focusing on the epidemiological level, i.e. the high mortality rates and human tragedies observed in Italy and Spain, which give rise to an immediate and ethical desire for solidarity. On the economic level, however, the situation is somewhat different.
It is true that the slump in the tourism industry has hit countries like Spain and Italy particularly hard. On the other hand, export-oriented countries such as Germany or smaller euro states whose prosperity depends vitally on international trade are also threatened by a particularly severe recession, as global trade is heading for a sharp contraction. Germany and Finland, for example, were far more severely beset in the economic turmoil of 2009 than Southern European states. If the proceeds from corona bonds were to flow to countries based on the severity of their recessions, then it remains quite unclear whether this will ultimately benefit particularly indebted eurozone countries. For this to be the case, assistance would have to be distributed based on public debt levels. In that case, however, there could be significant mismatch between where assistance is needed and where it is actually provided, thus contravening the principle of solidarity.
Corona bonds can hardly be both – a solidarity instrument that supports countries that are particularly affected by the crisis and a stabilization instrument that provides funds for countries with high debt levels. In the medium term, they may even make access to the capital market more difficult for highly indebted countries. They are the wrong instrument – even if one disregards the legal and institutional issues that an introduction would raise.
This article was first published in the German daily “Börsen-Zeitung” on 9 April 2020.