The EU is reluctant to definitively break the taboo of Eurobonds despite the war

The essence of taboos is that they are difficult to break. And that of issuing joint debt was an entrenched taboo among the countries of the European Union (EU) that was only overcome in response to the coronavirus pandemic. The European Commission places bonds from June 2020 to finance the recovery funds, Sure first and Next Generation EU later. In the last days, before the economic impact of the war in Ukraine after the invasion of Russia, another "massive issue" of joint debt for defense and energy would have been put on the table, according to Bloomberg. For now, the Community Executive has preferred to deny it.

Frans Timmermans, vice president of the European Commission, assured this Tuesday that there are no such plans. On the other hand, the European Commissioner for the Economy, Paolo Gentiloni, acknowledged that "new tools must be found to address the issues raised by this crisis, especially in defense and energy independence". He also explained that there is little room to redirect the post-pandemic recovery fund to respond to the war in Ukraine.

The placement of joint debt by the EU serves to mutualise the risk of default –very different when compared to Germany, considered the most reliable issuer in the eurozone, with, for example, Greece–; to guarantee sustainability and alleviate the interest burden –the bill that is paid each year for the debt– of the most over-indebted countries, such as Spain –currently only facing an annual payment of around 2% of GDP despite the fact that the debt is close to 120% thanks to the minimum cost (see graphs)–; and, lastly, to facilitate the task of the European Central Bank (ECB), which is at the crossroads of responding to the rise in inflation without tightening financing conditions choking off economic growth, already threatened by war in Ukraine.

The expansionary monetary policy of the ECB itself has been indirectly fulfilling these objectives since 2012, which the strongest economies in the eurozone denied to the point of endangering the existence of the EU during the Great Financial Crisis of 2008 and especially in the debt crisis of the later years. And the shock of the pandemic broke the taboo of crowdfunding: what seemed impossible happens naturally now, but it is not easy to overcome it a second time.

The European Commission has been placing bonds since June 2020 for Sure unemployment aid – the tool that has made it easier for Spain to subsidize ERTEs (temporary employment regulation files) and contain the unemployment rate after the pandemic shock. For this program there is a limit of 100,000 million euros of debt. Another 800,000 million will be issued for the reconstruction fund. In total, 900,000 million European debt, about 5% of the EU's GDP.

"To finance the Next Generation EU, the European Commission – on behalf of the European Union – will obtain loans on the markets at more favorable costs than many Member States and will redistribute the amounts," explains the EU itself. An objective that, for the time being and given the market reception of these Eurobonds, seems fulfilled, and with projection.

"Now the crisis in Ukraine is a new challenge, and in order to deal with the consequences of this crisis, the governments of the countries of the euro area will be forced to increase their public debt sharply again, starting from levels that are already very high", laments Eric Dor, director of economic studies at the IESEG School of Management, who considers that, "therefore, it is clear that over-indebted countries need a continuation of the support of the ECB and/or an additional mutualization of the debt".

"If we want over-indebted countries to increase their defense spending, for example, it is absolutely necessary to provide them with some support, in the form of debt monetization or mutualization, or a combination of both", proposes this French economist.

For his part, the economist José Moisés Martín sees it difficult for the solution to go through new joint debt, "with much of the Next Generation still unprogrammed." His bet is that "resources from the recovery funds will be redirected with some limited issue, especially for Eastern countries."

The First Vice President of the Government and Minister of Economic Affairs, Nadia Calviño, estimated this Wednesday in Congress between "10,000 and 12,000 million" euros the fiscal impact of all the measures taken to cushion the impact of the rise in energy prices in companies and recognized that, however, "it is not enough" and for this reason the Commission has been asked for a "determined" response to reinforce them.

From the Community Executive it has already been proposed as a first step that the states intervene in the electricity market to control prices, set by a system under which the most expensive megawatt of all those generated ends up being paid, now the one that is achieved with a shot of gas.

The minutes of the last meeting of the ECB, which was held before the invasion, show that some members of its governing council were already in favor of a "prudent normalization" of the extraordinary measures adopted in the spring of 2020 to prevent the coronavirus pandemic turned into a financial and liquidity crisis similar to the one in 2008.

The ECB will meet again this Thursday, March 10, and it is expected that it will once again close the door to a rise in official interest rates this year, even assessing new expansionary measures before the expected end of the emergency purchase program of debt as of April, despite the peak of inflation as consequence of the impact on the energy and raw materials from the war in Ukraine and as a response to the risk of stagflation – price increases without economic growth.

Before the war in Ukraine, the ECB already left room to increase its presence in the market if it considered it necessary to contain an increase in financing costs, especially critical for over-indebted economies such as Spain's, and increased the ordinary program for acquiring bonds of 20,000 to 40,000 million per month from April, until October.

At the moment, Spain continues to enjoy unbeatable financing conditions. For the first time, creditors ended up paying on average for the debt issued in 2021. And in 2022, until February, the cost of the bonds placed remained at 0.43%, below the average cost of all outstanding debt , which is at a historic low of 1.55% and will therefore continue to decline.

In its latest Debt Observatory, Airef recognized that "low issuance rates have made it possible to reduce and stabilize the financial burden despite a notable increase in indebtedness", which it estimates will drop to 113% in 2023, from 118 .7% of 2021.

Regarding sustainability, AIReF pointed out that "the invasion of Ukraine raises the risk of a stagflation scenario in the European Union, where high inflation could become more persistent, unleashing upward spirals and second-round effects that would complicate the process of normalization of monetary policy. On the other hand, it considers that "a rise in interest rates on sovereign debt would have a limited impact on interest expenses due to the high average life of the portfolio in the short term".

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