The recent economic response package in Europe falls short of “true” fiscal solidarity, but a limited, jointly financed Recovery Fund could go a long way to help.
Last week’s meetings of European finance ministers were timely, to say the least. As the COVID-19 pandemic spread across the continent, the national policy responses have been uneven, both in terms of timing, but also in terms of budgetary resources committed—ranging from very little in some countries to more than 20% of GDP elsewhere. This partly reflects the (perceived) severity of the crisis but also shows the unevenly distributed fiscal space available in different counties as debt-to-GDP ratios in the larger economies range from about 60% in Germany to 135% in Italy.
Yet, at the same time, the impact in terms of death toll has been much harder on countries like Italy and Spain. Their respective healthcare systems have been put under severe stress and their economies have slumped into deep recessions, likely worse than those experienced in 2008/2009. With less fiscal space at the national level, these countries have led a renewed push for their vision of solidarity—a further liability mutualisation via joint borrowing at the European level, dubbed “Corona bonds”. These countries have been supported by several other member states, including—importantly—France. On the other side of the debate, the EU’s “frugal four” (Austria, Denmark, the Netherlands and Sweden), supported by Germany, have been historically lukewarm about expansionary fiscal policies in general. In fact, these countries have opposed some of the policies quite vehemently, including joint debt issuance. Instead, they perceive existing instruments such as the European Stability Mechanism (ESM) and the associated access to preferential lending as a sufficient display of solidarity, in combination with other measures. In many ways, this is an old discussion; during the European sovereign crisis in 2011/2012, similar suggestions to “Corona bonds” had been floated by some but were opposed by others for fear of open-ended financial commitments.
This inevitably meant that the task at last week’s first conference call of the enlarged Eurogroup finance ministers and the subsequent overtime wrap-up was evidently a tricky one: how to bridge opposing views of solidarity? Can European solidarity only be guaranteed via joint debt issuance or are there other ways to provide adequate support to countries that require more government borrowing but are constrained by their lack of fiscal space? Can solidarity be a loan or does it have to be a grant? The noise level in the press had increased dramatically over the previous few weeks, with recriminations flying back and forth between “the North” (i.e., the frugal four) and “the South” (i.e., Italy and Spain).
European Crisis Response Measures
Assessing the Measures
The overall sum of measures (€540 billion, or a bit more than 4% of eurozone GDP, not taking into account the Recovery Fund) certainly makes for an impressive headline but the devil is, as usual, in the detail. First, access to SURE and the ESM facility appears to be designed as transitory, and might not come on more attractive terms than market borrowing as long as this is feasible; in fact, to the contrary, given where front-end sovereign curves are currently trading. In other words, the effective resource envelope in use could collapse to something much smaller than €340 billion for those SURE and the ESM. Second, EIB lending is demand driven, and the scaling-up process could take a good amount of time. Finally, while the Recovery Fund (still) has some potential to develop into a true solidarity instrument based on joint borrowing for a joint cause, statements by some of the ministers involved have already sown doubts even before we know any further details.
Forging a joint borrowing capacity with meaningful open-ended commitments by national member states requires overcoming constitutional hurdles—as well as societal opposition—in some member states, and continues to be a bridge too far to cross, even at the current stage. That said, dealing with the fallout from COVID-19 and the ensuing recovery effort is clearly a well-defined public good with massive spillover effects across economies in an integrated area such as the EU and especially the eurozone. Moreover, it is not clear a priori whether export-oriented economies will fare better or worse in this recovery as the world moves toward more robust supply chains—in other words, “winners” and “losers” within the eurozone have yet to be defined.
For those reasons, we think a more convincing public case can and should be made that, in the face of the current crisis, joint financing of at least a limited common recovery effort, such as the one under consideration, should be perceived as true reciprocal solidarity in everybody’s eyes and not just a one-directional transfer scheme as some seem to believe.
Find out more about Western Asset's Fixed Income solutions:
Legg Mason Western Asset Australian Bond Fund
Legg Mason Western Asset Cash Plus Fund
Legg Mason Western Asset Global Bond Fund
Legg Mason Western Asset Macro Opportunities Bond Fund
The eurozone, officially called the euro area, is a monetary union of 19 of the 27 European Union (EU) member states which have adopted the euro (€) as their common currency and sole legal tender.
Corona bonds are joint debt issued to member states of the EU. The funds would be common and would come from the European Investment Bank. This would be mutualised debt, taken collectively by all member states of the European Union.
In April 2020, the European Union floated the idea of a Recovery Fund worth up to 1.5 trillion euros ($1.64 trillion) with bonds guaranteed by member states. EU finance ministers last week agreed on a package of measures worth half a trillion euros to cushion the blow of the coronavirus pandemic but left unresolved the most contentious question of how to share the financial burden.
The European Commission (EC) is the executive body of the European Union responsible for proposing legislation, implementing decisions, upholding the EU treaties and managing the day-to-day business of the EU.
The European Union (EU) is an economic and political union established in 1993 by members of the European Community. The EU now comprises 28 countries after its expansion to include numerous Central and Eastern European nations.
The European Central Bank (ECB) is the central bank for the European Union (EU).
COVID-19 is the World Health Organization's official designation of the current coronavirus disease.
Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.
Debt-to-GDP ratio is a measure of a country’s financial leverage, calculated as the country’s debt divided by the size of its economy.
The European Stability Mechanism (ESM) is a permanent rescue funding program to succeed the temporary European Financial Stability Facility.
The European Investment Bank (EIB) is the European Union's nonprofit long-term lending institution established in 1958 under the Treaty of Rome.
Under the Outright Monetary Transactions (OMT) or bond-buying program, the European Central Bank (ECB) would offer to purchase eurozone countries’ short-term bonds in the secondary market, adding liquidity to the financial system.
Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.
All investments involve risk, including possible loss of principal.
The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.
The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).
This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.
This material is only for distribution in those countries and to those recipients listed.
All investors and eligible counterparties in EU and EEA countries:
In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6, Building Three, Number One, Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4. D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.
In the UK, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the UK Financial Conduct Authority.
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH.
Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.
All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.
This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.
All Investors in the People’s Republic of China (“PRC”):
This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.
This material has not been reviewed by any regulatory authority in the PRC.
Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.
This material has not been reviewed by any regulatory authority in Korea or Taiwan.
All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.
All Investors in Australia and New Zealand:
This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827). The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.