DUBAI — On Thursday evening, the EU leaders are due to meet to discuss the package of short-term liquidity proposals agreed by the Eurogroup two weeks ago. In the interim, unresolved differences of view on the ESM credit line and on the recovery fund have appeared recalling divisions inherited from the 2012 sovereign debt crisis. We see a political deal at hand that would exclude for the moment the recovery fund. The EUCO should give a broad and unclear mandate to the Eurogroup to explore possibilities to support the post-pandemic economic activity, without referring clearly to debt mutualization. There are mostly four subjects on the agenda of the EUCO meeting on Thursday: 1) the package of €540bn agreed by the Eurogroup on April 9 consisting in ESM credit line with soft conditionality, SURE and EIB loans, 2) the design of the recovery fund, 3) the set-up of the multiannual financial framework (MFF) for the period 2021-27 and 4) discussions about an European roadmap to lift containment measures. The Eurogroup emergency package The main sticking point of the agreement negotiated by the finance ministers should concern the ESM credit line. The Eurogroup agreed on soft conditionality, referring to the need that the credit line will be used only for "direct and indirect" healthcare costs related to the COVID-19, whereas in normal times countries asking for the help of the ESM need to sign a Memorandum Of Understanding detailing painful structural reforms to implement. Despite these more favorable conditions, Italy's Prime Minister Conte has immediately rejected the idea of activating the ESM after the Eurogroup announcement. To reach a political agreement and get the approval of Italy and others, the ESM should be made more attractive than standard ESM programs by: • Allowing countries to borrow above 2% of their GDP or €240bn. • Increasing the maturity of the ESM loan above 12 years and the grace period above 5 years. • Reducing the spread over the funding rate charged by the ESM to cover ESM costs close to zero versus ten basis points under standard programs. The design of the recovery fund The Eurogroup mentioned the need to discuss "innovative financial instruments" for the recovery fund without mentioning explicitly debt mutualization and coronabonds. This vague expression used not to offend any country is the perfect example of the politics of imprecision. As a consequence, every member states understood what they want to understand. The Netherlands understood that there would be no debt mutualization while Italy, Spain and France considered the door is now open to a serious debate about coronabonds. The latter countries have launched over the past two weeks a media blitz in favor of coronabonds, as evidenced by the two below quotes from President Emmanuel Macron and Portugal's Prime Minister Antonio Costa: • Macron to the Financial Times last week: "We are at a moment of truth, which is to decide whether the EU is a political project or just a market project. I think it's a political project...We need financial transfers and solidarity, if only so that Europe holds on." • Costa, April 11: "We need to know whether we can go on with 27 in the EU, 19 (in the eurozone), or if there is anyone who wants to be left out. Naturally, I am referring to the Netherlands." Tensions over this subject are likely to grow ahead of the EUCO meeting, with the latest move coming from Germany's Chancellor Merkel indicating Monday to participants in CDU leadership meeting that eurobonds are wrong path. The easiest part: The legal and institutional framework The legal basis for burden sharing is article 122 of the Treaty on the functioning of the European Union which specifies that: "Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the Member State concerned. The President of the Council shall inform the European Parliament of the decision taken." Ideally, for the sake of simplicity, the recovery fund should be institutionally plugged into the existing EU financial architecture and backed, at least partially, by the EU budget. The most difficult part: How to fund it The next question is how to finance the recovery fund. Proponents of coronabonds must be clearer on what they mean by coronabonds, how much they want to achieve, how the allocation of revenue will be done and why coronabonds are more beneficial than issuing debt at national level that will be purchased by the ECB. Spain has the beginning of an answer. Monday, the Spanish government released a non-paper, which is quite common prior to crucial European Council meetings, detailing the functioning of the recovery fund. It calls for the issuance of up to €1.5tr over the next two to three years, financed by perpetual debt and disbursed in the form of grants — and not debt (thus avoiding massive indebtedness) — to Member States through the EU budget. Linking the recovery fund to the EU budget is an idea already mentioned by France and that Germany could hypothetically accept as it does not imply legal modifications. Repayments would be financed by own resources, such as carbon border tax. Countries that have previously endorsed the idea of coronabonds could perfectly support this proposal, which is the most detailed to date. But we are still very far from an agreement. As the ECB is literally cleaning up all the secondary market with the start of the PEPP, the risk of sovereign debt crisis is close to zero, which reduces significantly incentive to reach a consensus. The most likely outcome of Thursday's meeting is that the EUCO will give a broad and unclear mandate to the Eurogroup to explore possibilities to set up and finance the post-pandemic recovery fund, without clear mention of coronabonds. The set-up of the MFF for the next six years The set-up of the MFF for 2021-27 in light of the crisis should also be part of the discussions. So far, we haven't had much insights regarding the position of each Member States. Once again, the Spanish non paper provides interesting proposals, notably the introduction of a real stabilization function for the euro area through unemployment reinsurance (which will certainly arouse strong opposition from the Netherlands and other countries from the "Frugale Four") and investment stabilization. Discussions over the MFF are likely to last for weeks. The European road map to lift containment measures The European Commission is expected to present into further details the "joint European road map towards lifting COVID-19 containment measures" it has released a few days ago. Actually, the 15-page document does not propose real coordination at the European level. Basically, the only reference to some sort of coordination is summarized by this part: "At a minimum, Member States should notify each other and the Commission in due time through the Health Security Committee before they announce lifting measures". It is essentially wishful thinking as several Member States have already unveiled exit strategy without referring to the European Commission. — The writer is head of macro analysis, Saxo Bank
