Euro area bonds to be discussed at informal EU summit, officials say

French President Francois Hollande and like-minded euro zone leaders are expected to promote the idea of mutualized European debt at an informal summit in Brussels this week, increasing pressure on German Chancellor Angela Merkel to drop her opposition to the proposal.

Senior EU and US officials said Hollande raised the topic of euro area bonds – bonds jointly underwritten by all euro zone member states – during G8 talks at the weekend and would again push it when EU leaders meet in Brussels on May 23.

He is expected to have backing from Italian Prime Minister Mario Monti, Spanish Prime Minister Mariano Rajoy and the European Commission, which has long been a backer of euro area bonds, producing a feasibility study on them late last year before the initiative was pushed to the background.

The rapid deterioration in the euro zone debt crisis over the past month, with Greece’s potential exit from the 17-country currency bloc no longer taboo, has brought the idea back to the forefront, with many economists and policymakers arguing it would be one of the best ways of restoring market confidence.

“The euro bonds debate is back front and center and Hollande will have support from other leaders if he raises it,» one EU official said.

“It’s not something that’s going to happen overnight – there’s a lot that needs to fall into place first – but there is a desire for a plan of action toward euro bonds.”

The summit on Wednesday is scheduled to focus on growth and investment, with European Council President Herman Van Rompuy wanting leaders to agree specific steps to stimulate growth and create jobs across the EU.

Proposals are expected to include boosting the paid-in capital of the European Investment Bank and plans for ‘project bonds’ underwritten by the EU budget to finance infrastructure.

The aim is to agree ideas that can be formally signed off at the next summit on June 28-29.

But the victory of Hollande’s socialist party in France has not only shifted the euro zone crisis debate more towards growth, while not abandoning austerity, it has also given renewed voice to ideas that Merkel has successfully pushed aside over the past two years, including debt mutualization.

Merkel has said she is not opposed to jointly underwritten euro area bonds per se, but believes it can only be discussed once the conditions are right, including much closer economic integration and coordination across the euro zone, including on fiscal matters.

That remains a long way off.

In its paper on what it calls «stability bonds», unveiled in November, the Commission said it was not an idea that could be deferred forever, saying the severity of the crisis – which has only worsened since – meant quicker action needed to be taken.

“While common issuance has typically been regarded as a longer-term possibility, the more recent debate has focused on potential near-term benefits as a way to alleviate tension in the sovereign debt market,» the paper said.

“In this context, the introduction of Stability Bonds would not come at the end of a process of economic and fiscal convergence, but would come in parallel with further convergence and foster the establishment and implementation of the necessary framework for such convergence.”

That is language that Monti, an economist and former European commissioner, has supported in the past and is expected to second in the discussions on Wednesday.

“Whatever the timeframe was before on moving towards euro bonds, it’s now even shorter because of the worsening in the crisis,» a second EU official said.

“There needs to be a discussion on jobs and growth, but there also needs to be a discussion on specific steps that can be taken towards euro bonds.

Several proposals, aside from the Commission’s, have already been circulated for well over a year. One, called a debt redemption fund, was proposed by a group of German ‘wise men’.

That proposal would involve mutualizing the debts of euro zone countries over and above 60 percent of GDP – the debt limit set out in the EU’s stability and growth pact.

Another idea put forward by the Bruegel think tank would involve mutualizing all debt up to 60 percent of GDP, with any debt over and above that limit having to be underwritten by the specific country alone.

Economists have argued that the best way of restoring confidence in bonds issued by euro zone sovereigns is for the debt to be collectively underwritten by all the countries. However, that would put a large burden on Germany, the EU’s biggest economy, to finance the debts of other member states.

As well as resolving the region’s debt problems, EU leaders are also expected to discuss how to tackle a deepening banking crisis, with the banking systems in both Greece and Spain under severe strain.

One idea is to allow the European Financial Stability Facility, the euro zone’s 700 billion euro rescue fund, to help recapitalize banks directly, rather than lending to individual countries that then lend it on to the banks.

But Germany opposes direct lending by the EFSF to banks, saying it is up to individual member states to ensure the stability of their banking sectors. [Reuters]