European bond not a fix-all solution, care needed in promoting it abroad

As Greek yield spreads over Germany hit fresh highs on concerns about the potential restructuring of the Greek public debt and rising funding costs in peripheral eurozone countries, mainly Portugal and Spain, the government appears to be betting a lot on the so-called E-bond. But the common issuance of these bonds by member states backed mainly by the creditworthiness of the core EMU countries will neither be a panacea for Greece nor can it rule out with any certainty the rescheduling of its public debt down the road, as some think. It is easy to understand why Greece, Italy and other peripheral countries of the eurozone favor the common issuance of eurobonds and equally understandable why Germany has come out against the idea. But many analysts, Greeks and others alike, think the government’s and the conservative opposition party’s high-profile campaign to promote it in the rest of Europe is hurting its chances. These analysts think the country is essentially undermining the chances of the E-bond, citing the animosity which exists in some segments of the German political elite and the public as well as in some other core eurozone countries against Greece. According to them, the country would have been better off if it engaged in a silent diplomatic campaign in favor of the E-bond and let others lead the charge. Remember that in early December 2010 Jean-Claude Juncker, president of the Eurogroup and prime minister of Luxembourg, and Giulio Tremonti, the Italian finance minister, called for the creation of a European debt agency in an opinion piece in the Financial Times. Such an agency could issue eurobonds worth up to 40 percent of the EU’s gross domestic product and would be able to finance issuance of up to 50 percent of each country’s eurobond debt and 100 percent of its debt if the country were unable to borrow on international bond markets. The proponents’ main argument is that such a move would insulate member states from speculative attacks while allowing them to pursue contractionary fiscal policies. As expected, German officials have come out against it, saying it would require fundamental changes to EU treaties and undermine market discipline imposed on fiscally irresponsible states since they would have fewer incentives to follow prudent budget policies. Moreover, the Germans are concerned the common issuance of E-bonds will increase their own borrowing costs since they will be essentially the main underwriters of these bonds. It is no secret that many analysts and others think Germany may bow to peer pressure if Spain, whose economy accounts for about 11 percent of the eurozone’s output, needs a bailout since the funds available under the European Stability Mechanism (ESM) and the European Financial Stability Facility (EFSF) are not enough. A number of Greek politicians, bankers and others appear to share the same view, saying that it is highly probable that Germany will finally agree to the idea of the common issuance of E-bonds in coming months. They also argue that Greece may not need to reschedule a good portion of its public debt in private hands if this indeed turns out to be the case. Of course, they all agree that a rescheduling of the 110-billion-euro loan from eurozone countries and the IMF will be needed regardless. Still, a number of knowledgeable analysts abroad, and even here in Greece, think that they are making a mistake. On the one hand, it is difficult to see why Germany will consent to the EU issuing E-bonds anytime soon. The fact that Greece has been talking about extending the maturities of the 110-billion-euro loan for months without this actually happening, reportedly due to German objections, should have provided a lesson. Even if Spain ends up needing a bailout, the funds could come by bolstering the resources of existing mechanisms rather than issuing E-bonds. Even if Germany decides to go along with the E-bond project, this will take place on its own terms. So it is difficult to see how the largest economy in the eurozone can agree to any common bond issuance where drawing rights can exceed 10 percent of each country’s eurobond debt and not ask for a pricing formula where the less frugal countries pay a higher cost. In other words, the benefits to a highly indebted country such as Greece of an E-bond will likely be less than many think. This means the country should look very seriously at all other options, including a rescheduling of its public debt maturing between 2014 and 2016 a la Uruguay in addition to the extension of payments on the 110-billion-euro loan. Of course, it should do its best to avoid a haircut on its public debt to avoid being shut out of the markets for a long time although this is the only way to cut its public debt-to-GDP ratio at more reasonable levels fast. It would be better if any efforts to reschedule debt coincide with a primary budget surplus in order to have more negotiating power over its creditors but this is not likely until the end of 2011 at best. All in all, the E-bond issuance will most likely not be a panacea for Greece and its politicians should adopt a more careful and diplomatic approach when promoting it abroad, knowing the damage they could cause due to the country’s reputation in Germany and elsewhere. Moreover, it is wrong to think the common issuance of E-bonds will render a debt rescheduling redundant.