Eurobonds

The head of European sovereign ratings at Standard and Poor's (S&P) cast a shadow over proposals for eurobonds on Saturday when he said a joint bond issue by eurozone countries would likely be given a junk rating.

"If it is a several and not a joint guarantee, then it would be the weakest link approach," Moritz Kraemer told delegates at the European Forum Alpbach in Austria, adding that "it depends on how the euro bond would be structured."

"My understanding is that it’s a bond similar to the jumbo bonds in Germany," where smaller federal states lacking volume join forces to issue bonds and "everyone guarantees just his own bit," he said.

"If we have a euro bond where Germany guarantees 27 percent, France 20 percent and Greece 2 percent then the rating of the euro bond would be CC, which is the rating of Greece."

Kraemer stressed S&P wasn’t in any talks with the European Union on a potential issue of euro bonds.

Ongoing debate

The debate about the possibility of the eurozone issuing common bonds has been going on for some time. Countries like Greece, Portugal, Spain and Italy, which are sometimes referred to collectively by the acronym PIGS, are demanding that they be introduced, while countries like Germany, Austria, the Netherlands and Finland steadfastly reject the idea.

Eurobonds underwritten by all of the countries that use the euro would benefit those with weaker economies. Their debt would be underwritten by stronger economies, which would result in lower borrowing costs for them.

Germany, Europe's biggest economy, would contribute its best-possible credit rating to the mix and wind up with higher interest rates in return.

How much would eurobonds cost Germany?

For Germany, the Munich-based Ifo Institute for Economic Studies estimates the increase in costs associated with the introduction of eurobonds at between 33 and 47 billion euros ($66 billion).

Gustav Horn, the director of the IMK Macroeconomic Policy Institute disagrees. He believes the rate for eurobonds would only be "slightly higher than the German interest yield – taking into account the fact that Germany would lose its status as one of the profiteers of the crisis." Recently, worries about the crisis have a fuelled a flight by investors into German government bonds.

"The German finance minister has benefitted from this a great deal," Horn said. "For him, the cost of taking on new debt has never been so low."

Martin Schulz, the chairman of the Socialist block in the European Parliament also plays down fears of "horrifying figures." He concedes that eurobonds would come at a cost, "but that they would be much cheaper for Germany than constantly increasing the rescue funds - or even a collapse of the euro."

Right thing to do from a psychological point of view?

Schulz adds that eurobonds also make sense from a psychological point of view.

"The high rates of interest imposed on the so-called PIGS countries are the result of the lack of confidence in the markets that these states can pay off their debt and that the richer countries really back the currency union," he said.

Schulz says in this respect, eurobonds would be a signal that the countries using the euro believe in a common future.

Peter Bofinger, a member of the German Council of Economic Experts says he believes eurobonds would eliminate the risk of individual countries going bankrupt.

Nothing new from an economic point of view

Bert Rürup, who chaired Germany's Council of Economic Experts until 2009, sees common bonds as a logical progression in the process of European integration. In fact, they already exist, Rürup told the Bonn-based daily newspaper General-Anzeiger. If the European rescue fund can issue bonds, as eurozone countries agreed back in July, then these bonds were already de facto eurobonds, he said, dubbing them "eurobonds light."

Hans-Werner Sinn, the president of the Ifo institute, agrees, but he turns the argument the other way around: Precisely because these common securities are nothing new, the eurozone should allow time for the instrument that has been agreed on to have an effect, before reaching for another.

Sinn sees eurobonds as a "sweet drug" because they remove the incentive for countries with massive debts to implement austerity measures. If such countries enjoy the same interest rate as Germany, why would leaders want to make deep budget cuts that would reduce their chances of re-election?

Blue bonds and red bonds

Proponents of eurobonds say this argument is invalid. They point to an idea put forward by the Bruegel Institute, a Brussels-based think tank.

It would limit the amount of debt that eurozone countries could finance with so-called "blue bonds" to 60 percent of the gross domestic product. That is the debt limit set out in the Maastricht Treaty. For any additional debt above that ceiling, countries would have to issue "red bonds." These bonds would be underwritten by individual countries. This, so the argument goes, would create an incentive for them to keep debt under control.

Heribert Dieter of the German Institute for International and Security Affairs in Berlin argues that while countries would pay lower interest rates on debt below the 60-percent ceiling, "one would have to pay much more, much higher risk-related premiums for everything above that."

Market discipline or political mechanisms?

Dieter sees eurobonds as an attempt to replace market discipline with mechanisms. However, Kai Carstensen, the head of business analysis and surveys at the Ifo Institute, argues that the relaxation of the Stability and Growth Pact proved that this strategy doesn't work.

"Back then too, there were good intentions," he said. It worked for a while, but "when things weren't going so well, Germany and France in particular lobbied for a more lax tenor," Carstensen added.

As a result, public deficits and total debt rose and during the financial crisis everything went out of control. Had Estonia not joined the eurozone at the start of this year, Finland would be the only country left that actually meets the convergence criteria.

Author: Zhang Danhong / pfd
Editor: Sam Edmonds