The Virus Will Force Europe to Make a Decision About Italy
(Bloomberg) -- As the coronavirus rages across the continent, European Union officials are starting to draw up plans for the day after.
With the death toll still spiraling and no end in sight to the restrictions that have brought the EU economy shuddering to a halt, no one yet has any firm idea of quite how extensive the wreckage will be. But it’s going to be vast.
Germany, the biggest economy and the one that has announced the biggest fiscal stimulus, is factoring in a 5% contraction at least and the European Commission estimates that each month of lockdown cuts annual output by another 3%. Last week the bloc’s leaders asked their council president Charles Michel and commission chief Ursula von der Leyen to start drafting a blueprint for reconstruction that would involve “unprecedented investment.”
Spain is pushing for a massive public spending program funded by joint debt issuance. The Germans are determined to avoid so-called coronabonds and want to use the euro-area’s bailout fund instead. France is framing its plan for a temporary recovery fund, also funded by joint bonds, as a potential compromise.
Hanging over all their discussions is the fate of Italy.
The EU’s third largest economy already had the weakest outlook and the most perilous public finances before the virus struck. Now it has also suffered the highest death toll and the longest disruption. The industrial engine around Milan in the north has been on lockdown for more than three weeks.
Officials in Brussels, Paris and Berlin may be talking about rebuilding the European economy. But a trickier question altogether will be what they can do about Italy.
The government in Rome is already reliant on the European Central Bank to underpin its finances and conservative estimates suggests its debt will be more than 150% of GDP by the time the outbreak is over. Its rebuilding will need billions of euros that can’t be raised from any orthodox source of funding and test the EU’s ability to help countries in need.
Discussions on the recovery planning are still at an early stage across institutions like the European Commission but the acrimonious and inconclusive discussions between governments so far underscore how difficult it will be to come up with a plan of action that member states will be able to agree upon.
Officials and their political masters are wrestling with a double conundrum.
On the one hand, the nature of the pandemic means all EU countries have been hit without discrimination and no one is to blame. They will all suffer a severe recession, higher unemployment, paralyzed industries and much higher debt. That’s one reason why the initial response was so decisive: EU deficit rules were suspended, Germany unleashed a massive stimulus program and the ECB deployed 750 billion euros of bond buying to stabilize markets.
Yet there’s also that nagging worry about the prospect of longer term support.
Mario Centeno, the Portuguese finance minister who leads meetings of his euro-area peers, hinted at this dilemma in his invitation to discuss the bloc’s short-term measures on a video conference next Tuesday.
The way Europe deals with the financial strains left behind by the virus will determine “the shape and the extent of the recovery, and, ultimately, the cohesion of the euro area,” he said.
Spanish Prime Minister Pedro Sanchez already last month called for an EU “Marshall Plan” of public investment that would be “the greatest mobilization of economic and material resources in history.” He has also strongly advocated for joint debt in the form so-called coronabonds, a call that was backed by the leaders of eight other European countries including France and Italy.
Such an instrument would ease pressure on highly indebted countries like Italy and, to a lesser extent, Spain and France. It would reduce the risk that they won’t be able to raise money on markets after a borrowing spree to finance their virus response.
The Germans and the Dutch are wary of ending up on the line for spending and borrowing they can’t control. They have argued for using the euro area’s bailout fund instead, but Italy and Spain have pushed against that, saying that it carries a stigma.
Behind that conflict lies a bigger debate about the euro area’s ineffective fiscal rules which failed to prevent either country running persistent deficits over the past decade.
In an effort to bridge the gap between the two sides, France proposed the creation of a temporary economic recovery fund that would run for five to 10 years specifically to support countries through the aftermath of the pandemic. It would be issue debt backed by the whole of the euro area to spread the financial burden of kick-starting the economy.
Others have suggested using the EU’s long-term budget, the main tool of direct fiscal transfers from richer to poorer member states, which is up for renegotiation this year.
With a ceiling around 1% of GDP for its seven-year period, and most of its funds channeled to farmers and infrastructure projects, the EU budget as it stands isn’t sufficient to stem a recession.
But Michel has floated the idea of a much larger special budget for the next one or two years, according to several diplomats briefed on the plans. For the Germans and the Dutch, that might be a more palatable way to spread the rebuilding costs that joint debts.
Finance Minister Olaf Scholz is already preparing the German public for helping countries like Italy in the short term with credit lines from the euro-area bailout fund. Those loans should come without the sort of conditions that accompanied previous bailouts, he told Germany’s public broadcaster ARD Thursday evening.
“This aid must come immediately and fast,” he said.
The Germans have signaled that the euro-area bailout fund should also be used for longer term support rather than any of the more novel structures their partners are proposing.
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