MNI: Fiscal Conditions For ECB Tool Prompt EU Disquiet

Eurogroup and European Commission officials are concerned that the European Central Bank’s proposed anti-fragmentation tool, which would cap member states’ bond spreads on condition they make efforts towards improving their finances, could undermine other European institutions’ role in monitoring fiscal policy, sources told MNI.

“If we have an anti-fragmentation tool, the entire European Semester and the SGP may become obsolete,” said one senior eurozone finance ministry official, referring to Stability and Growth Pact rules which govern borrowing in the bloc.

Conditionality for the new tool, which investors speculate might be announced at the ECB’s meeting on Thursday, could be based on the annual economic and fiscal policy guidance to EU states. Another possibility might be for the ECB to follow the Commission’s assessments as to whether EU states are meeting commitments under the NextGenerationEU programme for long-term structural, fiscal and growth-enhancing reforms.

Such approaches would threaten the fiscal role of the Commission and Eurogroup of finance ministers, officials said.

“States might be tempted to draft their budget plans to suit ECB criteria rather than those of the Commission or Council,” said one Brussels official.

DEBT SUSTAINABILITY

The ECB has indicated it will assess eligibility for the tool as an independent central bank. Some officials believe that means the ECB will develop its own debt sustainability metrics and market-based criteria to determine whether a given spread is caused by overshooting markets, and so qualifies for support. (See MNI SOURCES: Divisions Remain Over ECB's New Crisis Too)

But unravelling how much of a spread widening is due to market panic and how much to worsening fundamentals will be very difficult in practice, one former senior central banker said.

Commission and Eurogroup officials were relieved that the ECB has shied away from the idea of the using the EU’s Excessive Deficit Procedure, used to rehabilitate the worst fiscal offenders under the SGP rules, as a criterion for bond market intervention.

“That would have made it politically impossible for the Commission to launch the EDP against a country, knowing that would signal that such a country was on its own,” said one EU official. “It would have given the Commission a nuclear button,” which it would not have wanted to press, the official said.

Some EU experts, on the other hand, feel that the new tool would reinforce countries’ respect for the fiscal rules.

Former Director General of Market Operations at the ECB and Senior Fellow at Think Tank Bruegel Francesco Papadia told MNI that conditionality and ECB bond purchases by an anti-fragmentation tool would be mutually reinforcing.

“I see macro-conditionality and the anti-fragmentation tool mutually reinforcing each other: the expectation of support will provide an incentive to comply with conditionality, the respect of conditionality will reinforce the effect of the purchases under the anti-fragmentation tool, as the markets will see a country pursuing sound policies being assisted by the ECB. By the same token, non-respecting conditionality would cause big problems," Papadia said.

An ECB spokesperson declined to comment.