Brussels urged to step up region-wide bond issuance

The UK government isn’t the only European body politic that has come in for criticism from the IMF of late.

At the beginning of September, the fund called for a shake-up of the EU’s borrowing powers. It claimed that Brussels’ failure to provide more common debt issuance — the sale of region-wide bonds that are jointly backed by all 27 member states — risked exacerbating economic downturns and leaving governments short of the capital they need to green the bloc’s economy.

If the region did not do a better job of pooling its resources, the IMF warned, higher global borrowing costs risked leaving individual member states at risk of market turmoil.

“Multiple unprecedented shocks on top of already high debt levels complicate the conduct of fiscal policy,” the fund said. “Interest rates have been rising, and monetary policy normalisation continues apace.”

With monetary policymakers, including the European Central Bank, set to raise interest rates further in the coming months, the calls from the IMF will remain high on the ECB’s agenda.

It is not just IMF officials who are keen for Europe to step up its issuance. So, too, are markets, with investors eager to reduce reliance on Germany’s 10-year debt, or Bunds, and hold other safe euro-denominated assets.

The bloc has made greater progress on creating a common debt framework than many had thought possible. During the height of the Covid pandemic, member states came together to put in place an €800bn recovery fund that was financed through the issuance of common debt. A portion of those funds will be used to finance the green transition.

Yet many argue that, while the NextGenerationEU package constituted a step forward, it was less progressive than it might have been.

“It felt like the pandemic provided the opportunity to do something that would serve as an embryo for building a common fiscal capacity,” says Silvia Merler, head of ESG and policy research at Algebris Investments. “Instead, what came out of the negotiations was a hybrid structure, a little more tilted towards national priorities than many had hoped.”

The future of fiscal integration, says Mujtaba Rahman, managing director for Europe at Eurasia Group, will depend on how successful this “litmus test” is.

NextGenerationEU funds are yet to be disbursed to some member states. Brussels has refused to grant loans worth €36bn in the case of Poland and €7.5bn in the case of Hungary until their governments rectify concerns that they meet EU standards on treatment of the judiciary and the awarding of public sector contracts.

“For the Dutch and the Scandinavian member states, which have traditionally opposed fiscal integration, much will rest on developments in Poland and Hungary,” Rahman says.

“The debate is whether Brussels can successfully use the recovery fund to drag Poland and Hungary back into alignment with EU treaties. If that doesn’t work, then there will be a question about whether something like this is possible again in the future.”

Merler, meanwhile, believes the recovery fund will also put pressure on pro-EU lawmakers in countries such as Italy to convince citizens that region-wide stimulus packages can deliver economic growth.

“Accessing the funds has meant Rome has had to sign up to a lot of structural reforms,” she says. “This leading to actual growth is therefore not only essential from an economic standpoint, but for political and social cohesion.”

It felt like the pandemic provided the opportunity to do something that would serve as an embryo for building a common fiscal capacity

Other attempts at fiscal integration have been piecemeal and flawed. Cheap loans were made available via the European Stability Mechanism during the pandemic, but member states refused to draw on them.

“There’s no appetite for anything from the ESM because it was created during a crisis, and the perception is, if you’re taking money from it, you’re in trouble,” Rahman says.

“Even during the pandemic, no country wanted to go near ESM loans, even though they were very cheap and came with barely any conditions attached.”

Despite its complexities, common debt issuance is likely to remain on the agenda. From an economic perspective, the advantages of pooling finance are too great to ignore.

The recent feud over how to alleviate the region’s energy crisis highlights that a lack of co-operation continues to cost Europe dearly.

The price of power for the EU’s businesses and households has soared since the invasion of Ukraine, after Moscow cut supplies of its gas and Brussels imposed an embargo on Russian oil imports.

Collective bargaining — and financing — would potentially strengthen EU member states’ hand as they seek to find alternative energy sources at as low a price as possible.

However, some member states have opted to go it alone and introduce their own support packages — rather than waiting for any pan-EU solution.

A €200bn plan unveiled by Berlin in recent weeks led to accusations from outgoing Italian prime minister Mario Draghi and his counterpart in Hungary, Viktor Orbán, that Germany is undermining unity and the common market.

“Economically, the energy crisis shows that there is a really compelling argument for having common region-wide procurement, and creating a mechanism to support that,” suggests Merler. “But, as we have seen, several member states are not there yet.”