Sovereign Debt: Do We Need an EU Solution?
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Sovereign debt: Do we need an EU solution? High levels of sovereign debt have become a serious issue in the Eurozone. This does not just afect the individual member states: The European debt crisis has shown that difculties in one euro-area country can spread to the entire currency union. What strategies are being discussed for reducing sovereign debt? Would a stronger role for the EU help to reduce debt over the long term or should this be left solely to the member states? Why is sovereign debt a problem for the Eurozone? Many members of the Eurozone When the government needed money are heavily indebted. This applies to sta bilise the fnancial system, in- in particular to Greece, Italy and terest rates on its bonds rose higher No-bailout clause Portugal: The amount of sovereign and higher, increasingly calling into The EU Treaties state that debt has ex ceeded 130 percent of gross ques tion the country’s ability to pay. EU member states and the domestic product (GDP) in these three EU are not liable for the countries. But even the average level For a long time, the euro-area coun- debt of other members. This of debt among euro-area countries tries had no plan of action to meet a clause is meant to ensure amounts to 90 percent of GDP. This sovereign debt crisis. At its formation, that national governments limits governments’ leeway since the currency union was based on a draw up their budgets so they must spend ever-larger amounts no-bailout clause. But when the cautiously that they are on interest payments and have fewer Greek government ran into difcul- never at risk of a sovereign resources available to deal with ties with its fnances in 2009, a panic debt crisis. unanticipated events such as an broke out in the Eurozone. If a country eco nomic crisis. went bankrupt, the fear was that in- Emergency loans vestors would withdraw their money Since 2010, the euro-area The Eurozone is prone to end up in from other euro-area countries, ulti- countries have used bailouts a vicious circle of debt. Coun tries mately leading to departures from to provide loans to coun- that issue sovereign debt in their own the Eurozone and a meltdown in the tries that are in principle currency are relatively resistant to fnancial system. The euro-area coun - solvent but under heavy panics: If government bonds have no tries decided to provide emergency pressure from capital mar- buyers for a short period during a loans and, efectively, to bail each kets. Today, the European crisis, the domestic central bank can other out. Stability Mechanism (ESM) provisionally hold them. But the is used primarily for this. situa tion is diferent in the Eurozone. The ESM is under the con- The European Central Bank’s purchase trol of the euro-area coun- of individual countries’ government tries and can provide up to bonds is controversial and permitted, 500 billion euro in credit. at best, under very strict conditions. Thus, even Spain, which had a debt ratio of just 40 percent of GDP in 2008, experienced payment difcul- ties after the global fnancial crisis. “Projects to enhance EU growth potential “Joint liability combined with far-reaching could be fnanced by joint debt issuances.” national sovereignty would be the false path. That would do more to increase the problems Pier Carlo Padoan, Italian Finance Minister position paper by the Italian Ministry of Finance in Europe than to solve them.” in February 2016 Jens Weidmann, German Central Bank President in Die Welt on 25 June 2017 How can Europe reduce its debt? All euro-area countries want to re- But the correct path towards growth duce their sovereign debt, but there is controversial: While countries is no agreement on the best strategy. such as Italy and Greece call for Balanced-budget rule The Eurozone has three courses governments to stimulate growth A law, often constitution- towards reducing debt ratios: Govern- through higher spending, Germany ally anchored, that requires ments can cut spending, they can and other countries demand an im- gov ernments to barely stimulate growth, or they can seek provement in the overall economic spend more than they a haircut. framework. receive in revenue. The permitted defcit for most In the frst phase of the euro cri- Reducing debt via a haircut was ap- euro-area countries is sis, austerity policies dominated. plied in the case of Greece in 2012. - 0.5 percent of GDP. In Member countries only obtained This cannot be easily repeated for recessions, some what emergency loans in return for harsh multiple reasons, however. Negotia- more may be spent, while cuts in public spending. The Fiscal tions with creditors are very com- in periods of high economic Compact also introduced mandatory plicated and slow. Furthermore, growth less. balanced-budget rules into national banks often hold their own country’s law, and the European Commission gov ernment bonds so the fnancial Stability and can impose sanctions more easily system may collapse in the event of Growth Pact since 2011 if countries violate the a sovereign default. If other euro-area A package of European Stability and Growth Pact. Critics, countries are rather the primary rules designed to reduce however, point out that austerity creditors, a haircut would hurt their Eurozone members’ policies in an economic crisis deepen national budgets and confict with sovereign debt to below the downturn and thus reduce the the no-bailout clause. 60 percent of GDP over afected country’s solvency. the medium term. Among other things, it limits budget The larger a country’s economy, defcits in Eurozone coun- the lower its relative debt burden. tries to a yearly maxi mum Growth plays a key role therefore. of three percent of GDP. If Greece, for example, were to take The European Commission on no new debt and grow annually monitors compliance with at three percent, it would cut its debt the pact and can impose to GDP ratio in half by 2030. fnes in the event of any breaches. “I personally consider eurobonds to be a possible “Macron also ultimately proposes to move instrument in order to fnance future common tasks of towards harmonisation, and ultimately debt the European Union at favourable conditions. However, mutualisation. By contrast, I am in favour of they should not be used to shift debt that a state issued fnally adhering to the rules again.” in the past onto the backs of other Europeans.” Christian Lindner, Chairman of the FDP in an interview with Politico on 21 June 2017 Sylvie Goulard, Member of the European Parliament in the Frankfurter Allgemeine Sonntagszeitung on 13 May 2017 SOVEREIGN DEBT A look ahead SCENARIO 3 SCENARIO 1 SCENARIO 2 Common guarantees and control Growth and limited risk sharing Insolvency regime and haircuts In this third scenario, the euro-area countries decide in favour of a If euro-area countries cannot agree on a common approach, they In this scenario, the euro-area countries adhere to the original fscal union, that is for a large-scale sharing of risk and sovereignty. have to manage their sovereign debt within the scope of the rules principle of denying any common liability for sovereign debt. There Sovereign debt is guaranteed collectively. This entails extensive already in place. National governments by and large decide on are no longer loans for countries caught in an emergency. Instead, monitoring of national budgets by the European Commission so that their debt-reduction strategy by themselves. However, they cannot a sort of insolvency regime is introduced for states, allowing for an countries cannot issue limitless debt. implement large debt-fnanced economic programmes since the orderly haircut inside the currency union. For the fnancial system European Commission monitors compliance with the Stability and to handle such a shock, banks may no longer treat government bonds This model ofers maximum protection against speculative attacks Growth Pact. Minor violations are often tolerated in practice. as risk-free as they do today. Instead, they must build provisions in the Eurozone. It creates common safe bonds that banks use as a in case the bonds lose their value. capital bufer and can be purchased by the ECB in any acute crisis. In this scenario, some countries succeed in stimulating economic Countries with little or no debt would likely have to spend more growth through reforms and a redirection in government spending, Consequently, there are no disputes about austerity conditions money on interest payments than before, while heavily indebted while other countries in the currency union have to combat a stag- imposed by the European Commission since national governments countries would have to pay less. nating economy and ever-higher government debt. are given autonomous control of their budgetary policy. Depositors, banks, insurance companies and other capital-market participants These common guarantees and controls would substantially limit If the debt in a country gets out of control, the European Stability diferentiate between more and less solvent countries when buying the sovereignty of euro-area countries, however, which only a few Mechanism intervenes with emergency loans. It remains unclear, government bonds and thereby reward the efort to lower debt. seem to be willing to accept today. Furthermore, moving to a fscal however, whether it can act quickly enough to stop a crisis at its union does not answer the fundamental question of whether econo- inception and has enough resources available to stabilise large At the same time, Eurozone member states would remain susceptible mic crises should be met by increasing spending or adopting austerity member states as well. to market panics and speculative attacks as seen during the euro measures.