International Tax Panorama

Background

Since the outburst of the COVID-19 crisis, various European leaders are at crossroads on finding the best forms of economic response to the coronavirus outbreak. But the proposal to have a way of joint debt vehicle, or the “Coronabonds” as an instrument to finance the economic activity is becoming the talk of the ensuing debate. This type of bonds will be just like Eurobonds that will ensure European countries to get the emergency funds to support increased spending and lower taxes without increasing their national debt, during the COVID crisis. 

Many European countries have come up with significant packages, to facilitate a safety cushion against the predictable economic shock. However, they might not be enough due to the gravity of the crisis. It has been estimated that the fiscal bill for just COVID-19 could reach up to 5% of GDP, due to the two-month full lockdown followed by six months of half-lockdown, according to Olivier Blanchard, former chief economist of the International Monetary Fund and now a professor at Massachusetts Institute of Technology. Thus, corona bonds may come as a respite in a dire situation.

However, adopting such bonds ignites the age-old political debate of compromising sovereignty by EU nations. This very debate also got started about ten years ago during the euro crisis where the governments were at loggerheads over whether and how to bail out Portugal, Greece, Spain, and Ireland. However, the COVID crisis is different from the euro crisis as no single EU government can be entirely blamed for the crisis, which was done during the EU crisis.

What are Coronabonds?

The leaders of Italy, France, and Spain, as well as six other eurozone countries, sent a letter to Charles Michel, president of the European Council, demanding the issuance of ‘Coronabonds’, a form of joint bond issuance or collective debt instrument.

In this type of bond, debt would be mutual without affecting any country’s balance sheet, and the funding cost would be far lower, especially for most highly-indebted governments. The emergency measure would allow countries in the south to borrow at lower rates by combining their debt with the higher-rated northern European countries. The proceeds would then be distributed to member states in accordance to a previously agreed weighting. Here, all the countries would be jointly and individually liable.

In essence, the bonds would seek to soften the blow of the pandemic in heavily-debted countries like Italy and Spain, where the virus has so far killed more people than anywhere else. These bonds will help such nations to raise the money they need to fight the virus rather than taking the traditional route of national bonds. Moreover, the national bonds need to be issued continuously by the ECB to stabilize the interest rates, which might further weaken the state’s economy.  On the other hand, the ECB also faces a tough choice between either raising the bond limit or buying more bonds from other EU countries — deviating from ECB’s rule that debt must be bought in proportion to each euro member’s shareholding in the ECB. Thus, coronabonds will help the ECB to get out of such a tricky situation because they would not count towards the national limits, even if the cash is used to fund national stimulus measures.

Issues with Coronabonds:

1. Increased debt loads

The key issue is that some eurozone countries, such as Italy or Greece, are already suffering from high public debt loads, and they are afraid that the lockdown period will leave them in such a vulnerable financial state that their prospects for growth will be hugely compromised. According to Gilles Moëc, the chief economist at AXA, the insurance group, the debt load will increase for everyone, by at least 10% of GDP “and possibly much more. It might act as counterproductive to a country’s growth measures. 

Widespread protest from other EU nations

Voices of resentment have already started from countries like Germany and the Netherlands. Dutch Finance Minister Wopke Hoekstra recently warned his parliament that common debt issuance could undermine the incentives for prudent national fiscal policy, echoing earlier opposition to north-south fiscal aid packages after the 2008 financial crisis.

However, these countries have been heavily criticized by MEPs, domestic politicians, and Italian officials and mayors for its tough stance on EU measures by showing a lack of solidarity to its fellow EU countries, who are hard hit by the coronacrisis. This lack of solidarity is being viewed as a moral hazard to the EU community. 

Alternative measure: Should ESM facility step in ?

An alternative method of issuing ESM loans was also proposed in lieu of the fact that coronabonds mechanism will take some time to set up. Instead, the EU could use the Eurozone bailout fund, via the European Stability Mechanism (ESM), a permanent Luxmebourg agency that provides financial assistance, in the form of loans, to Eurozone countries or as new capital to banks in difficulty.

Here EU countries that have been allocated credit under the ESM will be eligible to receive a special, unlimited bonds buying program from the European Central Bank.

In the past, the ESM has already issued bonds to finance the adjustment programs of countries, including Portugal, Spain, Ireland, and Greece. The ESM could also lend an additional €400 billion or more than that if its capital is further increased. The overall advantages are a lower risk of illiquidity and lower cost of borrowing.

However, many are skeptical of using ESM due to the politics involved. Granting loans under the ESM requires meeting some conditions which can be made only on the basis of an adjustment program agreed with the European institutions. Meeting such conditionality requires specific policies from the recipient country, which might involve giving up their sovereignty. At the same time, there is a stigma attached to using ESM as it’s intervention can only be made by a specific country requiring its help for its particular needs. ESM was not created to deal with the crisis affecting almost the whole eurozone.

Lastly, ESM aid could also increase the recipient countries’ debt load.

Conclusion 

The proposal for a special coronabonds is a welcome move due to the uncertain nature of the COVID crisis. Also, it might help to create a full Eurobond, which was quite underway for a long time. Interestingly, the euro founders understood that the currency would create tensions first, which will lead to crises and then reforms. After completing the circle, the full monetary union will be a desirable outcome. Thus, adopting coronabonds would be part of that inevitable process.

It is also a bitter truth that the issuance of coronabonds won’t come off so easily, due to the protests from northern EU regions. The main hurdle lies in the broad transfer of economic and social competences from the national to the European level, which some politicians think as an adverse impact on their sovereignty. However, the issuance is inevitable even if it will take some debate time, due to the emergency situation.

As far as ESM facility is concerned, it could also be considered with some changes in the conditionality, specifically suited to address the present crisis. Also, countries can simultaneously apply for the ESM loans as a sign of solidarity, especially by countries that would not benefit from accessing the ESM as they have a relatively good rating.

In conclusion, coronabonds will act an instrument of true solidarity amongst member nations, which is necessary to capacitate the Union with the ability to finance European bonds. Thus, it is time to work with a renewed zeal in the face of the ensuing crisis, without fear or favour.