08 December 2020

Codogno/Galli: The reform of the ESM is not perfect, but for Italy, it can only have advantages

Almost two and a half years ago, we expressed on these columns some fears about the preparatory work for the reform of the ESM, and in particular on the Franco-German Meseberg declaration, which provided the reference framework for the reform then submitted to the Euro summit on June 28, 2018.

Our perplexities were only marginally motivated by the amendments to the text about to be made.

The most significant risk was that even the slightest underlining of certain concepts could give rise to a new ‘Deauville effect’. At the Deauville summit in November 2010, German Chancellor Angela Merkel and the then French President Nicolas Sarkozy introduced the concept of ‘Private Sector Involvement’ (PSI), i.e. the restructuring of public securities held by private individuals. That statement, which concerned the Greek case only, had destabilising effects on many Eurozone countries, including Italy.

 Our concern was that some clauses of the reform could have similar effects. In particular, our fears and that of many other economists were motivated by three points, which are evident in the Meseberg declaration and much more nuanced in the text of the reform: the repetition of the concept of PSI, albeit confined to exceptional cases; the introduction of the so-called ‘single limb’ Collective Action Clauses that facilitate debt restructuring; and finally the balance of powers between the Commission and the ESM in favour of the latter which is an intergovernmental body.

 Our fears at the time proved unfounded. Neither the Meseberg declaration, nor the subsequent publication of the reform text in July 2019, nor the approval of the text by the Eurogroup on November 7, 2019, had adverse effects in financial markets.

 It may be that our fears were excessive, or it may be that the decisions of the ECB intervened in the meantime have had the effect of avoiding tensions in financial markets. It may also be that the yield spread on the Italian debt was already considered sufficiently high by financial markets, due to the imprudent declarations and some concrete actions by the yellow-green government.

 Indeed, we would have preferred some points of the reform to be formulated differently, notably to emphasise the need for a careful cost-benefit analysis of the PSI in the specific conditions of each country. However, we believe that if the Italian Parliament today commits to reject the reform of the ESM treaty, the approval of which requires the unanimity of the Member States, it would cause serious damage to Italy. It would jeopardise good relations with other European countries, none of which seem to have doubts about the reform. It would preclude bringing forward the ‘common backstop’ for the Single Resolution Fund, an essential element of the banking union, which is scheduled for 2022. It would put at risk the negotiations ― already complicated ― on the Next Generation EU plan, of which Italy is the main beneficiary country.

 Someone said, to motivate opposition to the reform, that it would serve to force Italians to finance the bailout of German banks. It is a very bizarre theory, as the revision of the treaty allows the ESM to finance any shortcomings of the Single Resolution Fund (SRF) for banks without touching the pockets of taxpayers. With the possible ramifications of the current crisis in the banking sector, this safety net is no small feat.

 It is also not true that the ESM is the ‘old Europe’, as some say. In the future, country assistance programmes will be managed by the Commission-ESM tandem. It is the overcoming of the so-called Troika (Commission, IMF, ECB). Any future problems will be managed ‘internally’ according to the community approach, with the Commission being the only guarantor of compliance with European rules. It is a concrete manifestation of the solidarity of low-debt countries towards others; in fact, the most significant resistance in the past came from Northern countries.

 As obvious as it may be, the key point that critics seem to overlook is that any choice to go to the ESM in case of need is entirely in the hands of the country concerned. Therefore, the ESM is only an important additional option. The mere fact that the ESM exists has the effect of discouraging possible pressures in financial markets. This is because it can provide the country with the ammunition necessary to counter them and because it is the gateway to the Outright Monetary Transactions (OMT), i.e. ECB’s intervention which in principle could be unlimited.

 Finally, the ESM reform is different from the request for a line of credit under the so-called ‘healthcare ESM’ (Pandemic Crisis Support), with conditionality limited to the use of resources for health expenditure, which has been talked about a lot in Italy. Therefore, Italy should think about it a thousand times before rejecting the reform.