The Coronavirus crisis has become the news.
Like the virus, it is spreading from detailed public health analysis and discussion to almost all aspects of life and society. The Eurozone and economic policy has become the latest source of concern
Words and headlines from the great financial crash have reappeared:- Emerging markets, such as Zambia face a credit crisis; Global stock markets have had their worst quarter since 2008; Unemployment and Budget deficits are forecast to soar. On 16th March Reuters reported a forecast of a fall in Eurozone GDP of 3.9% . The Secretary General of the OECD on March 23rd is quoted as stating OECD “the economic shock was already bigger than the financial crisis” (BBC).
What are the implications for Ireland ?
The ESRI forecast a fall in GDP in Ireland of 7.1% for 2020, a rise in unemployment to 18% and a budget deficit of 4.3%.- ESRI, 2020, p. 6 available here. More recently (2nd April) the Central Bank forecast that short term unemployment could rise to 25%, and then fall to 10% by year end. GDP is expected to fall by 8%. Forecasts for the period beyond 2020 are not made. Future forecasts are likely to be even more pessimistic.
Banks in Ireland are once again exposed to bad debts, debt write offs and possible liquidity problems. While losses are likely to be large, they are unlikely to suffer similar losses to the financial crash of 2008-2012. As in the 2008-12 financial crisis, the IFSC is likely to be a major source of bad debts and financial instability, but mostly for other countries. Using a narrow definition, the global value of ‘shadow banking’ has grown to $51.6 trillion in 2017 (Financial Stability Board 2019, p. 5). Since 2011 Ireland and three other countries (Cayman Islands, China and Luxembourg) have accounted for two-thirds of the increase in the value of assets (Financial Stability Board, 2019). Assets such as Collateralised Loan Obligations (CLO’s) of highly leveraged special purpose vehicles in the IFSC (no employees, no fixed assets) have collapsed in value. Nearly half the world’s aircraft are leased from IFSC based highly leveraged firms. These assets will have fallen in value due to falls in income streams and because of the large growth of surplus aircraft.
Funding future Borrowing and Investment – Eurozone bonds
Coronavirus expenditures in Ireland are in addition to the financing of necessary infrastructure on hospitals, housing and public transport. The new Commission has stated as a key objective a greater emphasis on investment in projects that are consistent with the ‘European Green Deal’ and sustainable investment. These proposals will involve large public expenditures. Industrial restructuring may also involve public expenditures, for example a broadband network that is comprehensive and actually works.
Yet despite projected increases in borrowing interest rates on 10 year debt in Ireland and other countries are well below their peaks in the last financial crisis (Table 1). Interest rate differentials with German government debt although recently volatile , are far lower than the last financial crisis. This is mostly due to establishment by the ECB of a €750 billion fund to purchase Eurozone Member States debt, as well as corporate debt of “of sufficient credit quality”. Furthermore debt purchases will be made “by as much as necessary and for as long as needed” (ECB, Press Release, 18th March 2020).
Interest rates on 10 Year Government Debt
1st April 2020
July 4 2011 12.9
5th March -0.23
Dec 2011 7.19
13th Feb 0.79
June 2008 4.47
18th March -0.67
Source:- Trading Economics
Government debt levels in Ireland and other countries are below the peak crisis year of 2011. Debt levels may become a problem for Italy, but even in this case high debt levels may be sustainable at current interest rates, and indeed are lower than those in Japan.
A menu of supports were announced by the European Commission on 13th March. In addition the constraints of the financial and growth pact have been set aside without objections from any Member States.
Nevertheless the financing of future large deficits has become a subject of concern and of controversy. Nine members of the Eurozone (including Ireland) have advocated the issuance of Eurobonds (‘Coronabonds’) in a letter (25th March) to the President of the European Council. These are bonds denominated in Euros that would be guaranteed by the member states of the Eurozone as a whole, rather than an individual country. This is sometimes described as ‘mutualising debt obligations’.
The advantage of Eurozone bonds is that they are far less risky and hence lower cost for some eurozone members such as Italy. The disadvantage is that those countries with current less risk and lower borrowing costs will face higher interest costs and potential costs of funding bond redemptions.
Critics of the idea argue that issuing eurobonds would reduce the need in some countries for ‘fiscal discipline’, that is paying for expenditures from taxation. This has been described by the current Dutch Finance Minister as introducing ‘moral hazard’ to government debt issuance, meaning that those who undertake risky transactions will be shielded from adverse consequences. This may reduce penalties from undertaking risky transactions and could give incentives to only pursue risky transactions. Individual behaviour motivated by moral hazard is difficult to measure given complex environments with varying levels of information, regulation and motivation. At the level of a country it is akin to arguing that the Covid – 19 crisis can be solved by developing ‘herd immunity’ .
The Council meeting of Finance Ministers (26th March) deferred making a decision and sought a report from the Eurogroup to present proposals for a meeting on 7th March. One commentator (Wolfgang Munchau, Financial Times March 29 2020) explains this failure to reach a decision as being due to self-interest. He writes:-
“No crisis is ever big enough to stop European member states putting their narrow interests first” and “among German and Dutch economists, the idea that a backstop encourages irresponsible spending is a popular concept. More often than not, hiding deep prejudices and distrust of foreigners”.
Other arguments opposing Eurobonds, are that an existing EU Financial mechanism could be used, for example the European Stability Mechanism. The problem is that these loans are conditional on borrowing countries introducing polices, as in the last crisis’ may be inappropriate or exacerbate existing difficulties.
Of possible future significance was the announcement that work on a’ European Unemployment Reinsurance Scheme’ (SURE) would be accelerated. This would be financed by the EU borrowing €80-100 billion. This is effectively mutualised debt. Currently the EU is “only permitted to finance loans to countries. The EU cannot borrow to finance its budget.” The current proposal would be a move towards allowing the EU to both borrow and spend. But the sums discussed are too small as a solution to the crisis.
Adam Tooze (Financial Times, April 3rd) notes that:-
“the moment for an impressive display of common resolve has passed. Faced with the urgency of the crisis, the eurozone can offer nothing like an adequate programme of common public spending”.
A meeting of eurozone finance ministers on Tuesday 7th April to discuss proposals for ‘eurobonds’, as well as other measures, again failed to reach agreement after all night discussions and will reconvene. According to the Financial Times this failure was largely due to failure to compromise by Italy and the Netherlands. Politico (Bjarke Smith-Meyer 4/8/20), says “Divisions between factions led by Italy and the Netherlands proved too wide to bridge”. Yet the Financial Times (8th April 2020) comments:-
t “The pandemic’s impact on the eurozone’s economy and public finances is so devastating that a common effort, with the united firepower of the European Central Bank, the EU institutions and national governments, is the only sensible way forward”.
The Issue of Solidarity.
Member States agreed at a meeting of the European Council (26Th March) “that everything necessary will be done to meet the challenge in a spirit of solidarity”.
However opposition to Eurobonds by the Netherlands (and other countries) is seen by other Member States as an absense of solidarity. In addition the Netherlands has been criticised because for many purposes it functions as a tax haven’ (Naomi O’Leary, Irish Times 31 March 2020). The prevalence of tax havens in turn, exacerbates the fiscal crisis affecting Italy and other countries.
A similar criticism could be made of Ireland as Ireland has many of the attributes of a corporate tax haven. Furthermore Ireland (together with some other member states, for example Luxembourg and the Netherlands) often withholds solidarity on a key EU issue - reform of corporate taxation. Reform or taxation requires unanimity amongst Member States and Ireland has opposed: a Financial Transaction tax; EU proposals for reform of corporation tax; a digital tax; an aviation fuel tax; and has failed failures to implement parts of the Anti-Tax Avoidance Directive.
Political parties have stated that they are committed to national sovereignty in relation to taxation rather than the principle of solidarity. For example the recent Fine Gael manifesto (2020, p. 51), states that “Fine Gael is committed to national sovereignty over taxation policy”. Other manifestos make similar points.
A past history of lack of consensus on reform of taxation is likely to make achieving consensus on issues of financing the current crisis more difficult.
The danger for Ireland is that solidarity requires mutual agreement, but cannot be ‘a la carte’.
Dr James Stewart is Adjunct Associate Professor at Trinity College Dublin. His research interests include Corporate Finance and Taxation, Pension Funds and financial products, Financial Systems and Economic Development.
He is widely published and his titles include Mutuals and Alternative Banking: A Solution to the Financial and Economic Crisis in Ireland (2013), Choosing Your Future: How to Reform Ireland's Pension System (co-author, 2007) and For Richer, For Poorer: An Investigation of the Irish pension system (2005).