How to Stop the Italians and the Dutch From Fighting

(Bloomberg Opinion) -- If there’s a constant theme in euro zone crises, it’s that meetings of finance ministers tend to underwhelm. This week’s gathering of the so-called Eurogroup to coordinate a response to the Covid-19 emergency was no exception.

After a 16-hour videoconference, the ministers failed to agree on a joint strategy and adjourned the meeting until tomorrow. Luckily, the European Central Bank is doing a sterling job in providing a safety net to governments as they face an unprecedented economic contraction. However, the image of a monetary union divided at a tragic time for all of its citizens is dreadful politically.

The Eurogroup is discussing four substantive issues. First, the deployment of the European Stability Mechanism, the euro zone rescue fund, to assist all countries with cheap loans worth up to 2% of their gross domestic product. Second, a system of guarantees, managed by the European Investment Bank — the European Union’s lending arm — to provide 200 billion euros ($217 billion) in liquidity to companies. Third, a European Commission proposal to set up a 100 billion-euro loan scheme to help the labor markets in fragile countries. Fourth, possible steps toward debt mutualization, including a proposal by the French government to create a temporary fund worth 3% of the area’s GDP, via the issuance of joint bonds.

The discussions have set the Netherlands against Italy — with France, Spain and Germany somewhere in between. The Dutch government is demanding that the ESM attaches some form of medium-term conditions to its loans, to ensure that borrowing countries are in a position to pay back their debt. It also opposes any form of “euro bonds,” a form of mutualized debt issuance for the bloc — a position that’s shared widely in the Dutch parliament. Italy wants no conditions on the ESM loans, arguing that the epidemic is not anyone’s fault. Rome is also pushing for euro bonds, as it fears its debt will be too high for it to manage after the crisis.

As I’ve argued in a previous column, these talks are largely irrelevant from an economic point of view, for now at least. After a slow start, Christine Lagarde’s ECB has proven very flexible in launching a 750 billion-euro program of asset purchases, ditching most self-imposed constraints on which bonds it can buy. This “Pandemic Emergency Purchase Program” is allowing all euro zone governments to borrow cheaply as they launch their fiscal stimulus plans to counter an inevitable recession.

This week, the ECB went a step further by relaxing temporarily its rules on which collateral it can accept from lenders when they take up liquidity from the central bank — for example, allowing Greek government bonds. The ECB has signaled effectively that it’s ready to take more risk onto its balance sheet, which will be hugely important if other sovereign borrowers — such as Italy or Spain — had to face rating downgrades.

However, the Eurogroup discussions do matter for the future. It’s not clear why Italy has pushed for the ability to borrow 2% of its GDP from the ESM now, only to then shun the ESM as “absolutely inadequate.” Its borrowing costs are after all still reasonable because of the ECB’s actions. But Rome has a point in demanding that any future ESM help should come with very few strings attached. There’s always a danger that it could lose market access during the crisis and will need to apply for a rescue loan.

Similarly, Europe’s response so far of getting the ECB to back the euro zone’s national fiscal policies is good, but it gives little clue about what will happen to those countries’ future debt levels, which will be very high.

Italy was wrong to push for euro bonds, along with a number of countries such as Spain. This was never a realistic option from a legal and practical point of view. Perhaps it was just a negotiating strategy to obtain more on other fronts such as the ESM, although it left investors wondering whether Rome could manage the crisis on its own. Still, the Dutch government, along with fellow hawks in Germany and Austria, would be wise to accept the principle that some limited mutualization of today’s debts will be needed after the crisis. A joint debt reduction fund would also ease the pressure on the ECB, when it needs to start thinking about how to reduce its balance sheet and raise interest rates.

The conflict between Italy and the Netherlands has already caused great political damage. The Dutch government is coming across as insensitive at a time of deep human crisis. The Italian government, with its vacillating and unrealistic requests, is playing into the hands of the country’s euroskeptics, including Matteo Salvini’s right-wing League.

A compromise — involving very limited conditions on ESM loans and no euro bonds, but a commitment to some form of future and limited debt mutualization — is possible. The euro zone should seize the opportunity.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

©2020 Bloomberg L.P.