By Cary Springfield – cary.springfield@internationalbanker.com
Under the current crisis conditions, one of the questions that have been raised concerns the opportunity of creating a common market for government bonds, for example, a euro-denominated bond market that would eliminate the benefits of currency diversification and influence the amount of reserves.
The building of such a market would unify the fragmented markets of the European public debt. In secondary markets, debt securities with the same coupon and maturity would be perfect substitutes regardless of the issuer location. The need for a common market has appeared several times during the use of the single currency, but the project never materialized. In good times, its costs have been perceived as too high, and in times of distress, associated advantages were considered insufficient to justify such an effort.
The global turmoil and the establishment of the financial stabilization mechanism (FSM) have led to various proposals to create a euro-denominated bonds market. The establishment and implementation of FSM can be considered as the first step towards the unification of European government bond markets and the entry of a common bond.
FSM will provide the necessary tools to extend loans to countries in difficulty. From what we know, there are five theoretical proposals on the features and scope of a future common bond (Table 1). The underlying idea is basically the same; what varies significantly is the method of implementation, Institut Montaigne (Bonnevay, 2010) especially following a completely different approach to the vision of the other four proposals.
These programs indicate that securities would be issued by a central authority, each issuance being guaranteed by the Eurozone member states. The maximum value is restricted to 60% of GDP, thus setting an upper limit on the size of the future market. The national securities markets will continue to coexist with the new segment, serving additional loans, and credit ratings of domestic instruments would be driven by country-specific factors. The market will offer a myriad of advantages, but the most important is increased liquidity and therefore attractiveness of the euro as a reserve currency alongside the avoidance of market speculation.
| Authors |
Initiative |
Features of the euro-denominated bonds
|
| De Grauwe and Moesen (2009) | Euro-denominated bonds issuances depending on EIB shares%.
|
Participation of EZ governments based on EIB shares;Coupon: the weighted average yield observed in the domestic markets of government bonds at the time of issuance;Securities will be distributed proportionately;For the corresponding percentages, national governments will cover interest rates.
|
| Jones (2010) | Dual bond structure:Responsible lending backed by euro-denominated securities, cheaper;Excessive loans backed by common government bonds, more expensive.
|
Limiting the issuance volumes: overall, maximum of 60% of GDP. |
| Delpla and von Weizsacker (2010) | Blue bonds, extremely safe and highly liquid;Red bonds, riskier, with varying yields depending on the fiscal policy credibility of each state.
|
Government debt to 60% of GDP, in the form of European common bonds (blue bonds);Different allocation of blue bonds debts shares by country (60% of GDP for fiscal solid countries and a lower GDP% for countries with a weaker fiscal position).
|
| Leterme (2010) | European Debt Agency-EDA | EDA will take over the existing securities and issue new bonds, according to the schedule set by the ECOFIN and the EZ states;Existing debt: EDA will group borrowers-differences in interest rates will reflect changes in the credit rating of the member states, maturing debt being replaced by uniform interest rate securities;Uniform rates associated with the new issuances.
|
| Bonnevay (2010) | Enhanced fiscal coordination between France and Germany | The first phase of the introduction, strictly applied in France and Germany- joint financing of long-term investment projects;Obligations Assimilables du Tresor (OAT), Bunds and euro-denominated titles will coexist in the capital markets and the residual value of national securities will be reduced annually;The second phase (also implemented by France and Germany), associated with a progressive increase in the number of budget items funded by Euro-denominated bonds (enhanced budgetary coordination);In the long run, the introduction of such securities in other states of the Eurozone too.
|
The proposal of Grawe and Moesen (2009) reveals some critical issues regarding the distribution of collective responsibility, payable coupon setting, due to potential market distortions driven by the introduction of the common bond, the decoupling from the European public debt market and non-significant financial integration growth opportunities.
In the context of Depla and von Weizsacker (2010) initiative, the disadvantages include the need for full participation and credible commitment, independence of administration, chaotic transition and the split from the European government debt market.
From the political arena, Junker and Tremonti (2010) propose a European Debt Agency, a successor to current stability fund that would issue common euro-denominated bonds. EDA should finance up to 50% of EMU member states issuances, guaranteeing a deep, liquid and integrated global profile market. Furthermore, EDA would support the transition from national to common securities. Advantages refer to lower financing costs, protection against shocks and market speculation and limited moral hazard based on fiscal discipline. However, the initiative is somewhat ad hoc and does not provide institutional details.
Proposals for the creation of a unified euro-denominated bond are not unanimously supported, with stronger northern Eurozone states being the major opponents. Their arguments outline cost redistribution, implicit and explicit guarantees from developed countries to the poorest and practical difficulties (Eijffinger, 2011).
Such an initiative could lead to moral hazard risk in states facing fiscal problems (at least in the short-run) and higher costs for countries with sound fiscal policies. The only viable long-term solution is a credible commitment from all EMU members to reforms and fiscal discipline.
Kosters (2009) shares the same view and notes that the euro-denominated bond market unification involving collective guarantees violates the no-bail-out clause in the Treaty of Maastricht. Bail-out operations must be avoided at all costs (although, paradoxically, many have already taken place).
Moreover, the market would determine collective losses incurred by all member states in the event of an imminent collapse, deepening the Euro-skepticism in EZ countries with AAA ratings.
The main advantages of a common market for euro-denominated bonds include increasing liquidity of the profile segment (conditional on participation in the new scheme), protection against shocks and capricious market discipline, guaranteed funding for all EZ states, and improvement of the international status of the euro. The main disadvantages relate to potential difficulties led by the free rider behaviors, tensions on the no-bail out clause, viability and political credibility. The project of a unified euro-denominated bond market involves the ex-ante creation of a powerful mechanism to enforce fiscal discipline within the Stability and Growth Pact by all EZ countries. We refer to the strengthening of the SGP preventive arm (by introducing, inter alia, the European Semester ) and the consolidation of the corrective SGP arm by introducing (semi-)automatic penalties.
In the context of a comparative analysis of advantages and disadvantages related the creation of a common bond, the unification of the public debt markets appears as an appropriate and necessary step for the development of the European financial integration. Euro-denominated bonds would reinforce the euro position as one of the leading international currencies, involving real benefits as a result of increased competition in relation to the U.S. dollar.
The drastic reform of tax provisions for the purposes of coordination and discipline is a very important prerequisite for the future progress of the European bond markets integration, supported by the success of the new project.