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14 Jul 2020

How to make EU bonds a safe(r) European asset

Moritz Kraemer

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If the European Commission’s proposal for a recovery fund is approved by member states, the EU would become the biggest supranational issuer in the world. To uphold the EU’s extremely high creditworthiness under a massively enhanced borrowing envelope, the Commission proposes that member states transfer up to 0.6% of gross national income to the EU budget per year until 2058, when the last bonds would be repaid. This amount will exceed the EU’s plausible annual debt service costs. But, explains Moritz Kraemer, member states’ pledges of future transfers to the EU budget are effectively unenforceable promises.

An EU break-up scenario may appear unlikely today, but so did Brexit a decade ago. A deeper political crisis within the EU could lead to promised payments being withheld, immediately jeopardising the EU’s timely debt service. If the bonds are to be rated AAA, the probability of such an adverse turn of events must be almost zero. It is difficult to make this assertion with confidence so far into the future. Investor doubts about the EU’s long-term survival, however exaggerated they might be, could lead to higher than necessary funding costs, which will have to be borne by European taxpayers.

As it stands, the biggest European institutional issuance programme would have the weakest of financial safeguards. Member states should provide more robust financial support. The following measures would support the EU’s own credit strength:

  • The most straightforward form would be unconditional guarantees with cross-default clauses (as in the cases of the EFSF or the SURE programme)
  • Provide the EU with a capital cushion (as in the cases of the EIB and ESM)
  • Grant the EU a stable and meaningful own-resource tax base, in line with the Commission recommendations, or
  • Provide collateral in the form of government bonds to guarantee the EU’s debt service on a rolling basis.