Germany ready to back rescue plan to help Italy fight virus

Birgit Jennen and Viktoria Dendrinou

German officials are ready to help Italy get through the coronavirus pandemic and are prepared to support an emergency loan from the euro area’s bailout fund.

The preferred option in Berlin would see Italy granted an enhanced credit line by the European Stability Mechanism with minimal conditionality, according to a German official with knowledge of the government’s thinking. While Chancellor Angela Merkel has said she’s happy to discuss Italy’s request for jointly issued coronavirus bonds to shore up euro members’ finances, the official said Germany isn’t ready to move forward with that idea.

The Germans also worry that Italy already had substantial structural problems before the virus struck and they may need to be addressed once it has passed, the official added. Euro-area finance ministers will hold a videoconference on Tuesday to discuss the next steps. Finance ministry spokesman Dennis Kolberg said at a press conference on Tuesday that all options are being discussed and the European Commission has said that the necessary measures will be adopted.

Italy’s bonds advanced and the 10-year yield dropped about seven basis points to the day’s low of 1.56% before rebounding somewhat.

Merkel’s government has unleashed an unprecedented barrage of budget measures over the past week in a frantic effort to help the German economy survive an increasingly stringent lockdown. The chancellor has invoked the crisis to suspend her commitment to a balanced budget, lined up a 550 billion-euro ($590 billion) public-guarantee program to keep companies afloat and on Monday signed off on an emergency budget. That inclues another 750 billion euros of measures such as additional spending, aid for companies, state-backed loans and loan guarantees.

Italy’s Trauma

Italy though has suffered the brunt of the damage so far, with its industrial engine room effectively shuttered since March 7 and more than 5,000 people dead. Italy’s public debt was at 135% of GDP before the outbreak hit, so it has little ammunition to shield its companies.

Prime Minister Giuseppe Conte has announced a 25 billion-euro stimulus plan, a effort that is dwarfed by the German program and likely to fall far short of what the economy needs. Bloomberg Economics forecast output could contract by 5.3% in the first quarter – and that was before the government halted all non-essential activities on Saturday.

To cushion the blow, the Germans have already made one big concession by endorsing the European Commission’s recommendation to allow extraordinary leeway to struggling nations within its budget restrictions.

Euro-area finance chiefs are optimistic that they’ll be able to secure another boost for Italy on Tuesday’s call, though success is not guaranteed, officials said. If they can get a deal, that would allow the bloc’s leaders to sign off during their videoconference on Thursday.

Strings Attached?

One sticking point may be the conditionality attached to a credit line.

Italian officials are arguing that since they weren’t responsible for the outbreak, European solidarity dictates that there should be no strings attached, according to two officials familiar with the negotiations. The Italians also want all member states to be given credit lines to ensure there is no stigma for them.

The Germans – along with the Dutch – insist that there need to be some conditions, even if they are largely symbolic.

A precautionary credit line from the ESM would pave the way for the European Central Bank to deploy its most powerful tool – unlimited purchases of a country’s debt. Known as Outright Monetary Transactions, the program was developed during the euro zone’s debt crisis in 2012 but has never been used. It requires a country already to have a credit line with the ESM.

Underlying the debate over how to support Italy, is a long running dispute at the heart of the euro project over how far member states should share their liabilities. Since the single currency was set up, Germany and several allies with robust public finances have tried to resist mutualizing their debts. The sovereign debt crisis forced them to accept some tighter financial integration with the ESM and the single banking regulator.

Joint Bond Issuance

Italy, with the support of France and Spain, is pushing for the bloc to take a further step toward fiscal union by jointly issuing bonds for the first time in order to finance the virus stimulus program. Following a conference call with leaders, Merkel said she would ask her finance chief Olaf Scholz to join talks on the proposal with the rest of the bloc.

But that’s as far as Germany is prepared to go, the official said. EU officials are drafting plans for how a such a mechanism could work despite the German opposition.

The official in Berlin argued that using the ESM is already a form of mutualized obligation because it can take on debt on behalf of the whole euro area.

ECB policy makers have signaled that they’d welcome fiscal measures such as ESM support or euro bonds. While they unveiled a 750 billion-euro emergency bond-buying program last week, they’ve also repeatedly stressed that they can’t save the economy alone.

Bank of France Governor Francois Villeroy de Galhau said in a newspaper interview published Monday that the rescue fund should be activated, and Bank of Portugal Governor Carlos Costa said jointly issued “coronabonds” should be considered.

“That could help,” Isabel Schnabel, a German member of the ECB executive board, told Frankfurter Allgemeine Sonntagszeitung in an interview published Saturday. “No country can be indifferent to what is going on in another European country – not only for the sake of solidarity, but also for economic reasons. I hope that this is understood by the politicians.”