Coronavirus Battle Throws Open Eurozone's Divide

ROME -- The euro survived its debt crisis, but the wounds never fully healed. The coronavirus is threatening to reopen them.

Fighting the pandemic is causing deep plunges in economic activity around the world and pushing up government deficits. Stable access to borrowing is vital for governments that know they will have to cope with a surge in debt for the second time since 2008.

In Europe's common currency zone, that is exposing an old gap: between financially secure northern countries such as Germany and the Netherlands, and southern countries whose ability to borrow is more fragile, such as Italy and Spain. Southern eurozone nations have less money to prop up their households and businesses during the health emergency, risking greater economic damage and a weaker recovery afterward.

The gap is leading to clashing proposals for European financial support. Northern offers of loans with strings attached strike the south as punitive and inadequate. Southern clamor to issue joint bonds sound to the north like a demand to use its credit card.

Recriminations in March have given way this week to a greater understanding in Northern Europe for the loss caused by the pandemic. Italy and Spain have between them suffered at least 25,000 deaths from the virus, and their strict lockdowns are pummeling economies that still bear scars from the last financial crisis.

"We are with you," Germany's mass-circulation Bild newspaper proclaimed in a message of sympathy for Italy on Wednesday. Dutch Finance Minister Wopke Hoekstra, who infuriated southern countries by suggesting their financial limitations stem from their own profligacy, conceded on Tuesday he should have shown more empathy.

The warmer tones belie continued disagreement about what to do. France and the European Union's executive have tried to offer compromise proposals. The specter of a divided eurozone remains. Unless the economic shock of lockdowns is quickly overcome, Italy and Spain are in danger of emerging from the coronavirus crisis as poorer countries. A renewed depression in Southern Europe would also be bad news for northern nations, whose industries and banks profit from the overall health of the region's economy.

"The eurozone has a supranational central bank but national fiscal authorities. Coordinating between those two is much more difficult than in the U.K. or U.S.," said Mujtaba Rahman, European head of political-risk consulting firm Eurasia Group. "Eurozone fiscal authorities are willing to act but some have more ability to move, others less, and that creates problems for the whole architecture."

Italy's EUR2.4 trillion ($2.6 trillion) national debt, already 136% of its gross domestic product, is the biggest worry. The path of the pandemic is unpredictable, but some economists say the debt could easily end up at 160% of GDP. Italy can afford to service such debts if long-term interest rates remain at historic lows -- something the pandemic could further entrench. But it would increase the need for tight fiscal policies, putting the brakes on an economic rebound.

A two-speed recovery could exacerbate Italians' growing disillusion with the EU and the euro. Surveys in recent years showed most Italians don't want to leave -- but also that many believe the bloc and its currency haven't been good for Italy.

The coronavirus crisis has further damaged the EU's image in Italy. No other EU countries responded to an early Italian request for medical supplies. Germany and some other countries initially blocked deliveries of masks and other equipment. More assistance is now flowing, but only after China and Russia exploited European inaction by sending Italy supplies with much propaganda fanfare.

The European Central Bank exasperated even EU supporters in Italy when its president, Christine Lagarde, said keeping a lid on Italy's borrowing costs wasn't the ECB's job. That sparked a selloff of Italian debt, since investors think the ECB is vital to keeping eurozone bond markets stable. The ECB quickly corrected its gaffe, announcing a EUR750 billion program of emergency bond purchases, which calmed markets down.

But national borrowing with ECB help may not be enough, say many prominent economists.

"Leaving it only to the ECB makes the situation more fragile," said Guntram Wolff, director of Bruegel, a nonpartisan think tank in Brussels. "The bigger this gets, the more ECB purchases can become politically contested, and there can be legal challenges to the ECB in Germany," said Mr. Wolff, who is German. "There needs to be a political acknowledgment that we sit in the same boat. If Italy can't afford a sufficient fiscal response, it's not just a matter for Italy, it's a major issue for Germany, through our interdependence in trade and financial markets."

To put emergency deficit spending on stronger political ground and make it work for the eurozone economy as a whole, said Mr. Wolff, Europe needs "a fiscal vehicle that sits between national responses and the ECB."

EU negotiations quickly become a soup of acronyms, buzzwords and treaty articles, but the proposals fall into three broad categories.

The Netherlands, chastened by criticism, is proposing financial gifts, but on a tiny scale compared with the eurozone's EUR11.9 trillion economy.

Germany wants Italy and Spain to use the eurozone's main bailout fund, which offers loans in exchange for policy conditions. But the loans wouldn't be much cheaper than bond markets, and they would add to Italy's already high debt. And sending EU technocrats to oversee Italy's economic policies is politically toxic in a country still smarting from EU-mandated austerity during the debt crisis.

Italy, Spain, France and several other countries want a bolder form of burden sharing: for eurozone nations to borrow money jointly and spend it where it is needed most. That would mean Italy's debts rise by less than the money it receives. But northern countries fear it would set a precedent for a European fiscal union in which their taxpayers subsidize other nations. That is as unpalatable in Germany as EU-imposed austerity is in Italy.

"If proposals are perceived as the start of a permanent fiscal union, they are dead immediately. Nobody wants that," said Mr. Wolff. "If a program is big but specific for the purposes of an extraordinary crisis, that can fly." He predicts a compromise that offers sizable help, but less than is needed.

If Europe doesn't share the debt burden from 2020's emergency, the ECB may have to buy up southern countries' extra borrowing and sit on it forever. "The debt would remain in national statistics, but as long as the central bank holds it, it ceases to be of economic significance: It's like a loan between different parts of the public sector," said Paul De Grauwe, professor of European political economy at the London School of Economics. "This is what governments do in wartime. There can be issues of inflation when central banks monetize the debt, but the problem in Europe now will be how to stop a spiral of deflation," he says.

Mr. De Grauwe, who is Belgian, argues northern eurozone members should support such a solution politically out of self interest. "When the pandemic ends, they need to make sure the eurozone economy can grow again."

Write to Marcus Walker at marcus.walker@wsj.com


  (END) Dow Jones Newswires
  04-03-20 0714ET
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