German Chancellor Angela Merkel speaks to French President Emmanuel Macron, via video link, at the Chancellery in Berlin, Germany, on May 18, 2020 on the effects of the novel coronavirus COVID-19 pandemic. © Bundesregierung/AFP via Getty Im

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Last Friday, the last t’s were crossed and i’s dotted on a new credit facility from the European Stability Mechanism, the eurozone’s rescue fund for its member states — marking a milestone on the long road to common borrowing.

The ESM originated as a bailout fund offering relief to countries locked out of the bond market. In exchange, the fund requested strict monitoring on recipients — which many of them found humiliatingly intrusive — to ensure they complied with demanding policy conditions for loans. This made it toxic in many southern European countries.

The new Pandemic Crisis Support, in contrast, is tantamount to an unconditional loan. To apply, a country needs only confirm that it will spend the money — up to two per cent of its 2019 national income — on Covid-19-related costs. Compliance with this minimal requirement will be checked within the European Commission’s run-of-the-mill observation of all EU governments’ public finances. There would be no “troika, [no] men in black”, as Spanish prime minister Pedro Sánchez put it this weekend, in reference to the trio — IMF, ECB and the commission — that tormented Greece during the eurozone debt crisis about a decade ago.

Economically, “it makes sense for member states to draw on the ESM when there is a gain to be made on funding costs” says Michala Marcussen, Société Générale’s chief economist.

“The politics, however, may prove a different story”, she says.

The most obvious candidates have fended off expectations they will tap the new facility. Italy has been most vocal in resisting with both the Five Star Movement and its former coalition member, the far-right Lega of Matteo Salvini, objecting fiercely. 

Mr Sánchez’s finance minister, Nadia Calviño, has said Spain does not need ESM support because it enjoys cheap access to market funding on its own. Similar statements have emerged from Portugal and Greece. The trauma of the eurozone sovereign debt crisis still runs deep, with governments fear a domestic political backlash from being seen as “rescued”, and worries that northern countries would find some way to use the pandemic credit to impose their will on recipients’ policies.

Luis Garicano, the leader of the Spanish liberal Ciudadanos group in the European Parliament, dismisses those fears: “Paris is well worth a mass”, he said, conjuring Henry IV’s conversion to Catholicism to solidify his claim to the French crown. Spain or other potential beneficiaries should not let the word “rescue” prevent them from tapping cheaper ESM funding.

In a worry shared by many observers of Europe’s economy, Mr Garicano also warns that the ECB may feel less flexible in its monetary support of sovereign bond markets after the German Constitutional Court ruling against an ECB bond-buying programme this month. 

For a country that signs up to the ESM pandemic credit facility — even if it does not draw down any funds — the ECB would have political and legal cover to unleash its power should bond market spreads widen unsustainably. “All we need is 19 signatures” from the finance ministers who endorse ESM loans, says one eurozone central banker.

“You would hope we will use the cheapest sources of funding and avail ourselves of the widest protection the ECB can confer”, says Mr Garicano. 

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Any worries that markets would take it as a sign of weakness to go to the ESM seem misplaced. For Ms Marcussen, “market judgment is currently being largely reserved for the European Recovery Fund” — the fiscal response the European Commission is preparing to add to the regular EU Budget. 

France and Germany have made a bold call for a €500bn grant programme. If the Franco-German plan is not adopted by the rest of the member states, markets could start doubting the prospects of highly indebted countries. Such doubts may in turn force those countries to tap the ESM’s facility.

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