|
|
Its aim would be to ease down the current unsustainable levels while implementing credible fiscal policy reforms in all eurozone nations.
A proposal: The European Redemption Pact
In the annual report released on 9 November 2011, the German Council of Economic Experts has put up for discussion the idea that European leaders consider one such potential mechanism, a European Redemption Pact. Resting on provisions made by the revised Growth and Stability Pact, this would combine joint and several liability and strong individual commitment in refinancing the eurozone members over the next couple of years and, simultaneously, provide a road map to each member country reaching a 60 per cent debt-to-GDP ratio within another two decades, after which the ERP would be set to expire.
As always, the devil is in the detail, and the proponents of accountability will have to fence adamantly for their principle being reflected sufficiently in the concrete design of the European Redemption Pact.
The key idea of the proposal is the separation of the debt that has been accumulated to date by individual member countries of the eurozone, into a part that is compatible with the 60 per cent debt threshold of the SGP, and a part exceeding this threshold.
Following the sequence of immediate refinancing needs in a roll-in phase stretching over the next couple of years, participants in the Redemption Pact shall be able to refinance themselves through a joint European Redemption Fund, until the amount of debt refinanced through the ERF reaches the current difference between the debt accumulated to date and the hypothetical debt that would just equal 60 per cent of GDP, ie the SGP debt threshold.
While each country will henceforth have to service its own debt financed via the new Fund until it is completely redeemed and the new Fund expires, participants will be jointly liable for the debt, thus ascertaining affordable refinancing cost for all participants.
Not eurobonds
The decisive difference from the idea of eurobonds, in addition to its limited duration, lies in the strings attached to the participation. Specifically, a serious commitment is required to safeguard that the debt not refinanced via the mechanism does not rise above the 60 per cent debt-to-GDP threshold again. This needs to be guaranteed by debt brakes being introduced in the participants' national constitutions.
If a participant failed to honour this commitment during the roll-in phase, the roll-in would be stopped for this country. In addition, the redemption of the debt would be ascertained by special tax provisions which are designed to generate revenue earmarked for servicing the debt. Finally, each country has to guarantee its debt in the Fund by a 20 per cent deposit in the form of international reserves (gold and foreign exchange reserves). Whenever a Redemption Pact participant failed to honour its commitments, the participant would forfeit the collateral deposited with the new Fund.
At the end of the roll-in phase, the size of the new Fund would be approximately €2.3 trillion, if all members of the eurozone participated which are currently not supported by the European Financial Stability Fund (EFSF). The two most important participants would be Italy with slightly more than 40 per cent and Germany with approximately 25 per cent. As time proceeds, the debt accumulated in the new Fund would be redeemed until the Fund is dissolved, which would happen in about 25 years. This redemption path will require tremendous efforts from the participant countries, and the task will be harder for the countries starting the process with a higher debt ratio.
The required primary surplus for Italy to achieve this objective would be 4.2 per cent of GDP for each year in the redemption period, assuming that nominal GDP grows at 3 per cent per annum, the new Fund were to confront refinancing cost of 4 per cent and the interest rate Italy has to pay is 5 per cent for the remaining debt. Achieving a primary surplus of 4.2 per cent of GDP over a prolonged period of time will require sustained fiscal discipline. However, the scheme should still be attractive to Italy despite the strict conditions attached to participation, since the joint and several liability of the Fund ensures lower refinancing cost. The primary surplus required for Italy to achieve the same reduction in debt without the ERF scheme (assuming an interest rate of 7 per cent) would initially be more than 8 per cent of GDP.
For the ERF's second-most important contributor, Germany, participating would reverse this advantage into a disadvantage, though Germany will only be convinced that participation in the new Fund is worthwhile if
The highest constitutional safeguards, in the case of Germany a referendum, will have to be put in place to ensure that the ERF does not degenerate into unconditional eurobonds.
Certainly, the European Redemption Pact is a grand scheme which requires bold action and a long term commitment to the eurozone. In return, it offers the promise of a definitive solution to the crisis by redeeming debt rather than piling on new debt.