April 10, 2020
Italy has folded for the sake of a deal. Plus ca change.
We would not normally publish today, the Good Friday bank holiday. But we decided to produce a briefing after all to put some of yesterday’s important news into context. There will be no briefing next Tuesday. We will be back on Wednesday, April 15.
The big news yesterday is no doubt the eurogroup agreement. As we wrote yesterday morning, it would have been unwise to bet against a deal, which did not stop some people from doing so. We have been through this before with the eurozone crisis. Then, as now, the problem was never an inability to reach agreement but the nature of the agreement itself.
Wopke Hoekstra and Roberto Gualtieri, the two principal opponents at the eurogroup meetings on Tuesday and yesterday, came back with diametrically opposed interpretations of what was agreed. Gualtieri said that conditionality for an ESM programme was off the table. Hoekstra said it was still there. They are both right. It is the job of diplomacy to find the right words to make this possible. EU diplomats are exceedingly good at that. Only fools ever bet against an EU deal. In this specific case, the text says access to the ESM is unconditional, but also says the standardised terms will be set by the ESM governing board. It probably will never get to this point but, if it does, the dispute is only postponed.
What interests us is the overall economic effects of what has been agreed, as opposed to the headline numbers. The only tool with any chance of a macroeconomic impact would be the recovery fund. Ministers kicked this issue back to the European Council, which had previously kicked it back to them. The text mentions innovative financial instruments, but gave no details of what that might mean. The eurobond discussion is not over, but eurobond proponents certainly missed an important moment during the crisis as momentum had built up in the discussions. We think this momentum is now fading.
What was agreed yesterday is well below macroeconomic relevance. The text claims that the discretionary measures by member states so far account for 3% of GDP. We flatly dispute that number. We suspect that it throws together measures at various stages in the fiscal pipeline. But experience shows that only a fraction of what is earmarked will ultimately get through. The amount of discretionary fiscal spending unleashed in the eurozone so far is small compared to the US and the UK. The automatic stabilisers will be higher, so in the end we have to look at the total fiscal effect.
The measures agreed yesterday are the following.
- A €2.7bn emergency support facility from EU budget resources, that is 0.03% (!) of GDP.
- An EIB lending facility for €25bn. This is good news but we urge readers not to buy into the spin, especially the large multipliers. The ECB did the heavy lifting on credit support. The impact of the EIB programme will be to support credit flows, but the marginal effect will be much smaller than it would be in normal times.
- An ESM enhanced-conditions credit line of up to 2% of member states' GDP as a benchmark. The 2% is not an accidental number. It reflects the size of the remaining funds in the ESM. The text refers to standardised terms, which implies conditionality in our view, and kicks the decision to the ESM governing bodies and EU institutions. Everybody who asks for one will get it, so long as they promise to spend the money on healthcare-related issues. We think this facility, and all the fuss made around it, is ultimately irrelevant. The ECB’s pandemic emergency purchasing programme makes a liquidity squeeze very unlikely this year. The PEPP supersedes OMT and, as we keep pointing out, the various limits, even the capital key, are irrelevant in an emergency. Furthermore, Italian politics precludes an ESM programme.
- A temporary credit programme by the European Commission to support national employment systems, under the acronym of Sure. The maximum size is €100bn. Again, these are credits.
This is it for what has been agreed. Mostly loans and lending support. We don’t want to be completely downbeat. The Sure facility will help especially those member states with weak unemployment insurance systems, like Italy, and those with insufficient provision to fund furloughed workers or short-time work schemes. The EU plugs important gaps in the system. But we should not fool ourselves that this any of this is macroeconomically relevant.
So, this leaves the still-disputed recovery fund to do virtually all the heavy lifting, or not. We fear that Jacob Kierkegaard is correct in his expectation that this fund will ultimately be folded into the EU’s budget. Where we disagree with him is that this can be leveraged to reach a macroeconomic scale. We have been there. The EU’s budget is of the order of 1% of GDP, of which most is firmly earmarked for non-discretionary programmes. Let us remember the last time that EU thought it could leverage its resources: the infamous Juncker investment fund. This was a paper tiger that mainly reshuffled existing investments into different categories. There was no perceptible impact on aggregate investment at the level of the EU. We expect the recovery fund to be in the same category: an attempt by the EU to prove its relevance, but without having any concrete effect.
So what’s the bottom line? We think the Italians have folded. The battle for the eurobond is lost. The re-nationalisation of policy is in full force. And we are set for another financial crisis soon, when the impact of Covid-19 on the debt sustainability of member states becomes only too clear.