Overcoming dissent on euro action

‘We have made our decisions and may go further’

Officials in Italy, the European country hardest it by the pandemic, are quietly confident that northern European creditor states will drop well-publicised opposition to expanding collective emergency fiscal facilities to aid southern states. They argue that the bloc faces an unprecedented synchronised downturn that only joint action can mitigate.

The European finance ministers’ meeting on 24 March failed to agree a comprehensive plan on euro area-wide measures, transferring decisions towards heads of government when they meet by video conference on Thursday – but divergences seem to be narrowing.

Pier Carlo Padoan, former Italian finance minister, now a Democratic party member of parliament in Rome, predicts that Europe will activate a combination of the European Central Bank and the European Stability Mechanism, the single currency’s €500bn bail-out fund, to help overcome the feared deep recession. Such collective action, necessary to back up national fiscal measures, is required to prevent a new wave of populism and euroscepticism, Padoan told an OMFIF virtual meeting on 24 March.

Padoan’s comments back the statement by Mário Centeno, president of the Eurogroup of euro area finance ministers, who after Tuesday’s meeting pointed to ‘broad support’ to harness the ESM. He mooted ‘pandemic crisis support safeguard’ that would grant precautionary credit lines. One large problem preoccupying the Banca d’Italia and Italian politicians is acute nervousness in Italy about the stigma of borrowing from the ESM. The Rome parliament is highly unlikely to accept any solution that involves ESM conditionality.

Italian politicians echo the adage of Jean Monnet, one of the European Union’s founding fathers, that Europe is ‘forged in crisis’. They universally see the coronavirus shock as an opportunity to relaunch measures for common euro area issuance, introducing an internationally attractive ‘safe asset’ that would attract large institutional investors from around the world to finance Europe’s post-virus development.

Italy is backing the long-mooted euro area budget to make individual states less prone to volatility in national bond markets. It wishes to advance an ECB commitment to intervene to prevent the spread between Italian and German government bonds exceeding 1.5 percentage points. This has been brought closer by invocation of an ECB move first discussed in 2016 for ‘flexible, yield contingent approach to interventions’.

Italy fears a scramble for funds on world markets as euro member states try to plug funding gaps. Fearing a new ‘competition between states’, one senior policy-maker says, ‘We need a bridge to overcome market shocks.’

Padoan told the OMFIF meeting, ‘We need an additional fiscal boost, which cannot be limited to countries’ national fiscal space but should be assessed and shared widely across the Union.’ The former finance minister said he would favour a large issue of EU-backed ‘corona bonds’ for improving healthcare systems and bolstering companies. ‘Let’s be creative in our solutions, there is the recurring trap of old feelings of mistrust amongst European countries which has to be overcome. This is a real test of European integration. If not now, then when? The enemy is common and invisible – it doesn’t carry a passport and it is a huge test.’

One influential Italian opposition politician says northern states that have habitually opposed further-reaching assistance for debtor states risked a major conflagration and even the break-up of the currency bloc if they block necessary action. He claims that all euro area countries are now ‘in the same boat’. With all European countries facing budget deficits of 8-10% this year, there could no longer be discrimination between debtor and creditor states.

The European Central Bank appears to have recovered ground, after initial faltering, with last week’s launch of the €750bn emergency bond-purchase programme, in line with measures by the Federal Reserve and other leading central banks. European central bank officials point to the extension of ECB action into the corporate bond field as evidence that the bank can spread action further.

One member of the governing council brushes aside scepticism by Germany and the Netherlands on increasing precautionary limits on government bonds that the euro system can buy in its public purchase programmes. ‘This is a crazy debate.’ The limit on central banks holdings of 33% of government issuance – grounded on preventing the ECB becoming a major creditor in event of a national debt restructuring – represented a constraint only for Germany and the Netherlands, the least likely euro area members to encounter debt problems, he points out.

‘We have not yet discussed whether to raise these limits, we have simply said we would consider it if necessary. For the time being we can make necessary [bond] purchases to avoid a major deflation – a real risk if GDP falls by double digits – and reduce financial fragmentation.’ Pointing to the 23 March projection from the Munich-based Ifo economic research institute of a possible 20% year-on-year fall in German GDP if the crisis persists, the official says this should change German policy-makers’ minds about breaching previous taboos.

The governing council member stresses profound uncertainty. ‘Central banks have stepped in but they are not about to monetise debt. There is no helicopter money for now but we might do it eventually to pay employees, to provide a means of payment. We are trying to stop markets from becoming too nervous. We have made our decisions and may go further, we will have to wait for markets to stabilise.’

David Marsh is Chairman of OMFIF. For more on Italy’s fiscal response to Covid-19, join Riccardo Barbieri, director general at Italy’s ministry of economy and finance, for a virtual discussion on Friday 27 March.

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