The euro-zone rescue talks are irrelevant

The Covid-19 epidemic has forced the euro zone’s finance ministers to think of innovative ways to combat an inevitable recession. They met to discuss how to use the European Stability Mechanism (ESM), the single-currency area’s rescue fund, to help countries fund a large-scale fiscal stimulus.
Yet this debate appears largely irrelevant, at least for the moment. The European Central Bank has already launched a 750 billion-euro ($810 billion) asset-purchase scheme that will provide a meaningful safety net for euro-zone governments as they boost spending and increase their deficits. The ECB said its commitment to the euro has “no limits.” This is more important than any credit line coming from the rescue fund.
The case for ESM intervention rests on the idea that countries have vastly different amounts of financial firepower to deal with the economic crisis. Italy’s government debt stands at a towering 135% of gross domestic product, more than twice the ratio in Germany. Giuseppe Conte, Italy’s prime minister, said in an interview with the Financial Times that he’d like the ESM to lend money to all countries in the euro zone. Unlike past ESM rescues, which were conditional on signing up to a programme of austerity and structural reforms, Rome believes this one should come without any strings attached.
Finance ministers inched towards giving the Italians what they want. There appeared to be “very broad support” for the idea that countries could borrow up to 2% of their gross domestic product from the ESM. There was, however, a lack of clarity over what conditions (if any) the rescue fund would demand in return. The terms of these loans, including their duration and interest rate, are also unclear. Some more hawkish governments, including the Netherlands, appear very reluctant to offer overly generous conditions.
For all their heat, these discussions look like a relic of the past. An ESM credit line might be a useful addition to the toolkit of any finance ministry, but only if it’s remarkably generous. The ECB is already ensuring countries can borrow at a very reasonable rate, as demonstrated by the auction of Spanish government debt. Madrid raised 10 billion euros in seven-year debt, paying only the slightest extra premium to investors even though it’s battling an ever-more-deadly outbreak. So long as the ECB continues to exercise its calming presence, the only advantage of an ESM credit line would be slightly better funding terms.
Even then, the rescue fund’s intervention wouldn’t solve the long-term problem of debt sustainability. Countries will exit the Covid-19 crisis with much higher sovereign debt levels. For member states with weaker public finances — such as Spain and Italy — this will be especially problematic.
And this will be an issue for the euro zone as a whole. It will reduce the ECB’s scope to raise interest rates, since that may make it harder for vulnerable countries to refinance their debt. ESM loans don’t address this problem, since they’d still have to be repaid. Again, only the most generous of terms (a zero coupon, for example) would make a noticeable difference.
The rescue fund still has a useful role to play: as the ultimate backstop. The ECB intervention has been effective, but it may not be in the future if the virus impact worsens. Investors could turn against a country in spite of quantitative easing. In that event, the government concerned will need emergency help from the ESM.
—Bloomberg