Eurobonds or not Eurobonds?

European Union (EU) leaders have gathered on EU summit forum in June 28-29, 2012 in order to discuss any solution to solve debilitating debt. From this meeting, EU decided to allow Eurozone bailout fund so called European Stabilization Mechanism (ESM) to be utilized in directly rescuing troubled banks. Will it cure or at least ‘cool down’ the pressure in Euro area?

Being established in 1999, Euro area is Economic and Monetary Union (EMU) of 17 EU members which have adopted Euro as their currency. By adopting Euro, the economies of its members become more incorporated particularly in monetary policy. There are several advantages of adopting single currency: stable currency, business advantages and lower interest rate. Firstly, as the euro being used by large numbers of countries, the Euro itself could have enhanced its credibility which eventually become more stable against any speculations. Secondly, since there is no more currency exchange, business could transact across border without paying any hedging cost to insure themselves from any fluctuations. Lastly, the monetary authority in this case European Central Bank (ECB) could manage its monetary policy in the form of low interest rates which eventually benefits investment climate.

However, is there any coordination in terms of fiscal policy? Since first Euro ‘launching’, the Euro area member should have been ruled by Stability Growth Pact (SGP). This pact rules the Euro area members not to breach budget deficit at 3% of GDP threshold. This rule also requires the member to balance their debt not exceed 60% of GDP. However, the credibility of SGP is questioned since Germany and France ‘broke the rules’ but then prevents the sanctions. Furthermore, fiscal burden of Eurozone countries tend to expand in order to minimize the deficit. Eurozone’s economic security is more likely weakening. This deteriorating is reflected by its economic growth contraction, slowing manufacturing industry and dwindling job creation.

The other form of fiscal policy coordination that has been widely discussed is issuance of Eurobonds. Basically, Eurobonds are bond instruments issued and guaranteed by all member of Eurozone. Issuance of Eurobonds allows Greece, debt ridden member, to issue Eurobonds in order to increase monetary liquidity and to stimulate investment and consumption. However, Eurobonds issuance brings about several drawbacks that have been regularly discussed among Eurozone leaders. Firstly, most creditworthy member, for example, Germany would have paid higher interest rates on their debt. Secondly, it will create a ‘moral hazard’ issue since some of Eurozone members might have incentives to issue too much debt to profit from guarantee. Thirdly, the Eurobonds requires a very high coordination of fiscal policies by all Eurozone members.

Pooling euro area sovereign debts into common bond market would have a number of advantages. Firstly, Eurobonds would be vital step towards medium term of fiscal union and first step towards political union in long term. Secondly, a common Eurobonds issue will create large bond market in Eurozone which can compete with the dollar bond market. This also creates a market with a lot of liquidity. Thirdly, with the issuance of Eurobonds, could boost the investor confidence in ‘troubled’ members and have potency to increase business activity. This will lead to shrinking unemployment rate, and steady economic growth.

Furthermore, common bond in the euro area will be attractive and other investors to spread risk on their investments and achieve higher expected return than investing on US T-bills. The combination of improvements in investment and economy in the euro area will gradually bring back Eurozone to recovery. This recovery will be positive signals for EU’s economy or even global economy. If the Eurobonds is successful, it is expected to bring back Europe economic growth to be at level of 0.7%-1% and world economy may grow at level of 3.8%-4.2%.

Hence, with positive economic growth of Europe and world, economy in ASEAN-5 with Indonesia included in is also expected to be at level of 5.5%-6.0%. This expectation will affect positively to Indonesia economy both in financial sector and real sector. In financial sector, the recovery of Eurozone economy will lead to incoming both Foreign Direct Investment and Portfolio Investment from other countries. Nonetheless, Indonesia’s economy should be strengthening particularly in investment in order to achieve sustainable growth in the long run.

This paper is a personal opinion from Josua Pardede, Economist of PT BNI Securities.