The European Redemption Fund Proposal
This post was written by John McHale
The proposal for a Debt Redemption Fund made by the German Council of Economic Experts seems to be gaining a bit more traction (see here). This working paper from February provides a useful overview. Given that this is the only “eurobonds” proposal with anything approaching momentum, it is worth debating its merits.
Some of the basic elements:
· Countries would be able to finance an amount of debt (as a share of GDP) equal to the difference between current levels and 60 percent of GDP through the fund. This would occur as new funding needs (deficits/redemptions) arise
· The fund would have joint and several guarantees
· Repayments would be a constant share of GDP, equal to the ERF interest rate plus one percent divided by initial GDP. The repayment schedule is designed to fully repay fund borrowings in 20 to 25 years
· Countries would have to commit to reduce their total debt to below 60 percent of GDP. Longer term, it doesn’t appear that there would be additional commitments beyond the revised Stability and Growth Pact and Fiscal Compact. However, during the “roll-in” phase, countries would have EFSF-style adjustment programmes
· Would only apply for current programme countries after they had exited their programmes.
From the working paper:
Transferring debt into the redemption fund is organized by allowing participating member countries to refinance themselves through the 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 % of GDP, i.e. the SGP debt threshold . . .. The exact length of this transitional phase depends on the sequence of immediate refinancing needs. During this so-called roll-in phase, the participating countries fulfil consolidation and reform agreements which are comparable to the structural adjustment programmes of the EFSF. 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.
Payment-obligations through which the transferred debt is redeemed are expressed as a constant fraction of GDP. The scale of annual payment-obligations relates to the volume of transferred debt. It is set at a level that ensures that each country redeems its debt in the ERF within a period of 20 to 25 years. Accordingly, countries transferring more debt have to bear higher annual payment-obligations. As the ERF can only gain the trust of financial markets if the joint and several guarantee is upheld until the transferred debt is completely redeemed, payment obligations have to be constructed in a way that all participating countries complete the redemption of their debt inside the ERF at approximately the same time.
By agreeing to redeem their debt in the redemption fund within 25 years and to keep the remaining debt below the 60 %-threshold, participating countries implicitly commit to certain upper limits for their primary balances and debt quotas. The exact development of these figures depends on several assumptions on GDP growth and country specific refinancing costs. In addition, required primary balances are determined by the sequencing of refinancing needs that each country is allowed to cover through the redemption fund during the roll-in phase. In general, there are several options to implement the ERP, which differ mainly in the exact sequencing of refinancing via the funds.