As COVID-19 threatens an unprecedented economic crisis, the Council asked the Eurogroup on 26 March to present proposals for common fiscal measures to tackle the crisis within the next two weeks. So far, three models have been put forward by economists, that could serve as a template.

First, the creation of a Covid Credit Line under the ESM.

Second, the one-time only joint issuance of Corona-Bonds by the Eurozone-Member States.

Third, the creation of a new permanent fiscal capacity at EMU level that issues common safe assets.

This article ads to the ongoing debate by offering a pragmatic legal perspective. It focusses on the first two proposals, as proposals for a permanent fiscal capacity at EMU level require amending the TFEU, which seems unlikely to happen in the current political environment. It takes a closer look at their compatibility with EU Law, the ESM-Treaty and German Constitutional Law. It argues that, from a practical legal standpoint, the use of the ESM is preferable to issuing Corona-Bonds, because it could be implemented more quickly and offers a higher degree of legal certainty. However, jointly issuing Corona-Bonds would send the stronger political signal and they could be designed in accordance with Art. 125 (1) TFEU.

From health crisis to economic crisis to sovereign debt crisis?

A symmetrical external economic shock currently hits all Eurozone-Member States simultaneously. The short-term effects are already extreme. Forecasts suggest that the worst is yet to come. In order to counter the effects, almost all EMU-Member States have adopted fiscal aid programmes of unprecedented proportions, made possible by the first-time suspension of the EU Stability Pact. In the medium term, this threatens to cause a sharp increase in public debt. This could endanger their (re-)financing capacity. It also creates risks for the banking sector, as banks in the most vulnerable countries of the Eurozone still hold large amounts of their home countries government bonds. The vicious circle between states and banks may resurface and threaten the integrity of the Eurozone.

Use of the ESM for preventive purposes?

At first glance, the simplest way seems to be direct lending by the ESM. So far, the ESM has primarily fulfilled the function of a lender of last resort for the Eurozone-Member-States. Accordingly, until now, it has only used reactive instruments. These include, in particular, the loans to Ireland, Portugal, Greece and Cyprus, which were linked to far-reaching macroeconomic adjustment programmes. No Eurozone country is yet in a sovereign debt crisis due to COVID-19. But the ESM-Treaty also provides for preventive measures. In general, according to Art. 12 (1) ESM-Treaty, the objective of the ESM is “to safeguard the financial stability of the euro area as a whole and of its Member States”. To this end, the ESM-Treaty provides in Art. 14 two instruments which have not yet been applied: the Precautionary Conditional Credit Line (PCCL) and the Enhanced Conditions Credit (ECCL). The respective ESM-guideline regulates these in more detail. They aim is, to maintain market access for countries with still healthy public finances. The ESM grants the funds via loan or primary market purchase of sovereign bonds at the request of the state seeking assistance and after examination by the Commission and the ECB. The terms of the loan are set out in a Memorandum of Understanding. Both programmes initially run for one year, but can be extended twice for six months each.

PCCL is aimed at countries whose financial position is fundamentally sound. The ESM examines this on the basis of six criteria, inter alia: compliance with the requirements of the Stability and Growth Pact, sustainability of public debt and absence of problems in the banking sector that could lead to systemic risks for the Eurozone banking system. However, PCCL is not eligible, particularly for Italy. This can already be concluded from the EU Commission’s country report on Italy for the European Semester 2019, in which it was described as having “excessive macroeconomic imbalances”. The same goes for other states with weaker fiscal positions. If a country is not eligible for PCCL, but still has a healthy (“sound”) financial position overall, ECCL remains, which is subject to much stricter conditionality, albeit not as strict as those of a loan with full macroeconomic adjustment programme. Within the existing instruments of the ESM, ECCL is the right instrument for most of the weaker Member States.

A COVID-19 Credit Line under the ESM

However, the problem with PCCL and ECCL is their short maturity and their relatively strict conditionality. Thus, some call for a new special COVID-19 Credit Line (CCL) with much longer maturity and less strict conditionality. Would this also be covered by the ESM-Treaty? According to Art. 14 (4) ESM-Treaty, the ESM Board of Directors adopts guidelines on the implementation modalities of the precautionary financial assistance. It has already issued such guideline. The ESM-Treaty itself says nothing on the duration of the loans. These are only laid down in the guideline and could therefore probably be modified by amending it. However, an appropriately modified guideline would have to include instruments for continuously monitoring compliance and the possibility to terminate the loan in case of non-compliance, as Art. 3 ESM-Treaty calls for strict and appropriate conditions. This serves to ensure that the ESM and ultimately the Member States behind it incur no losses. Art. 7 (2) and (3) of the guideline on precautionary financial assistance already provide for the possibility of closing existing credit lines in the event of non-compliance. The state concerned would then have to submit an application to switch from CCL to a loan linked to a macroeconomic adjustment programme.

The ESM-Treaty allows issuance of precautionary financial assistance with a longer duration via a CCL due to the amendment of the relevant guideline, provided that the outlined requirements (appropriate and strict conditionality) are respected. 

However, depending on the specific conditions of the loan, national parliaments would most likely have to approve a corresponding use of the ESM. This is true particularly in case of Germany. Especially the German Constitutional Court plays an important role in assessing the legal boundaries of European integration in general and specifically Eurozone crisis measures from the perspective of the German Constitution. This became especially evident following the European Financial and Sovereign Debt Crisis (see cases ESM, OMT and PSPP). Under German Law, the national Parliament has to approve ESM measures in case they concern the overall fiscal responsibility (Haushaltspolitische Gesamtverantwortung) of the German Parliament (see Art. 4 (I) ESM-Finanzierungsgesetz – Act on the Financing of the ESM). This is the case, especially if the ESM seeks to grant new stability support to a Member State. This would clearly be the case with a CCL, irrespective of its specific conditions laid down in the Memorandum of Understanding or later in a respective facility agreement.

One-off joint issue of Corona Bonds by the Eurozone-Member states

The idea goes as follows. One time only, due to the COVID-19 crisis, the Eurozone-Member States jointly issue bonds with an aggregate value of up to 1,000 billion Euros (equivalent to approx. 8% of the Eurozone’s GDP) at a long-term maturity backed by their joint financial strength. The funds thus created would be used to support Member States that threaten to lose access to capital markets on acceptable terms. All Eurozone-Member States would be jointly and severally liable for the repayment of the bonds; the amount of interest and redemption payments could be based on the ECB capital key. It should therefore be possible to place the bond on relatively favourable terms on capital markets. Due to the low probability of default, Corona-Bonds would also represent safe assets that could be acquired in particular by banks in weaker countries.

However, many key practical questions remain open. How exactly would the modalities of distribution from the pool to the individual countries look like? What would be the terms of repayment? Which vehicle would be used to issue the bond? Who would manage the pool and process the loans from it? Could the ESM be used for this purpose? Would the ESM-Treaty have to be changed? Could banks use the bonds for refinancing with the ECB and would the ECB be allowed to purchase them as part of its secondary market purchasing programmes? One thing is clear: Corona-Bonds would have to be created by a temporary fiscal capacity at EMU level, which creates a pool of funds by issuing Corona-Bonds and then distributes the financial assistance via loans or primary market purchases to the Member States.

This raises two questions from the Union Law perspective: first, does the TFEU provide for a sufficient legal basis which allows for the creation of such a temporary fiscal capacity and second, are Corona-Bonds compatible with Art. 125 (1) TFEU. These questions can only be touched upon in the context of this short contribution and cannot be assessed conclusively. On the first question: Art. 122 (2) TFEU allows the Council to grant, under certain conditions, Union financial assistance to a Member State, which is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control. The Corona-Epidemic and the economic crisis that threatens to follow can easily be understood as constituting an exceptional occurrence beyond the Member States` control, which threatens severe difficulties. The only problem is, that Art. 122 (2) TFEU only allows for “Union financial assistance”, in other words, it must come from the Union budget. This is currently hardly sufficient. The question then arises, whether the Member States could finance such Union assistance via bond emission (Corona-Bonds). This is highly disputed. In favour of it, one could say that such a provision makes no sense without the possibility to (re-) finance such financial assistance. Therefore Art. 122 (2) TFEU provides a sufficient legal basis for Corona-Bonds. On the second question: In contrast to Eurobonds, whose admissibility under Union law is largely doubted, Corona-Bonds would only be issued once. No permanent mechanism for automatic joint liability for the national debt of all Eurozone-Member States, which would be incompatible with Art. 125 (1) TFEU, would be created. In light of the ECJ`s Pringle ruling, according to which Art. 125 (1) TFEU does not prohibit all types of financial assistance per se, such assistance would only be compatible with Art. 125 (1) TFEU if it did not provide an incentive for unsound fiscal policies and if it is necessary to secure the stability of the Eurozone. This Corona-Bonds could be designed in accordance with Art. 125 (1) TFEU. However, it depends on the specific conditions under which the financial assistance would be paid. If necessary, such arrangements would have to be accompanied by clarifications under secondary law pursuant to Art. 125 (2) TFEU.

Thus, the admissibility of corona bonds under Union law does not appear to be excluded from the outset. In addition, however, the question of compatibility with national constitutional law also arises, especially with regard to national budgets. According to the German Federal Constitutional Court, the German Parliament has to approve such measures if the concern its overall fiscal responsibility. Corona-Bonds would be issued at EMU level, they would require joint and several liability by its Member States. National States would therefore have to convey fiscal powers to the EMU level. Given the enormous volume envisaged, this would clearly concern the overall fiscal responsibility of the German National Parliament, and therefore require its consent.

Not least for the practical reasons laid out above, Corona-Bonds raise more complex questions than the use of the ESM. It is difficult for political decision-makers to resolve these issues conclusively and with legal certainty in the short time available. Thus, from a legal point of view, the implementation of a novel Covid Credit Line within the existing structures of the ESM is preferable to the issuance of Corona-Bonds. However, when using the ESM, the Member-States should acknowledge the current extraordinary situation to avoid stigma and to send the signal of solidarity needed in these times, e.g. by means of a joint declaration, flanked by corresponding rhetorical efforts by the political decision-makers.

Disclaimer:

The contribution reflects exclusively the personal opinion of the author.

This article has been published first on 4 April 2020 on VOX – CEPR Policy Portal, Centre of Economic Policy Research. A earlier German version has been published on Verfassungsblog.de on 26 March 2020.

References: 

Bénassy-Quéré, A, et. al. (2020), “A proposal for a Covid Credit Line”, VoxEU.org, 21 March. 

Codogno, L, van den Noor, P (2020), “COVID-19: A euro area safe asset and fiscal capacity are needed now”, VoxEU.org, 25 March.

European Commission (2019), “Country Report Italy 2019”, 27 February. 

European Council (2020), “Joint statement of the Members of the European Council”, 26 March.

Roubini, N (2020), “Coronavirus pandemic has delivered the fastest, deepest economic shock in history”, theguardian.com, 25 March. 

Südekum, J, et. al. (2020), „Europa muss jetzt finanziell zusammenstehen“, Frankfurter Allgemeine Zeitung, 21 March.

Tooze, A, Schularick, M (2020), “The shock of coronavirus could split Europe – unless nations share the burden”, theguardian.com, 25 March.

Author:

Julian Pröbstl is a Research Associate at the Max-Planck-Institute for Tax Law and Public Finance in Munich and a PhD Candidate in European Financial and Monetary Law at the University of Passau. His research covers European and International Financial and Monetary Law, Sovereign Debt Management as well as Financial Regulation and European Economic Policy. He was a visiting researcher at the University of Oxford and studied Law at the University of Passau.