ESM: a trap or an opportunity?

The second wave of the COVID-19 pandemic is stronger than anyone would have imagined. Our hospitals are suffering. Now more than ever, it is clear we need to invest heavily in our healthcare systems to improve their resilience and their capacity to endure emergencies like the one we are experiencing now.

There is a great deal of chance you have been hearing about the European Stability Mechanism, and about all sorts of reasons why countries should stay as far away from it as possible.

In this article, I will try to refute the allegations weighing on it and explain why it is a powerful instrument to help our healthcare systems weakened by the pandemic.

What is the ESM?

The European Stability Mechanism (ESM) is a European institution born in 2012. Its primary statutory purpose, as established by its founding Treaty, is to provide emergency aid to those countries facing temporary financial distress and unable to finance themselves on traditional markets. All 19 Euro Area Member States (EAMSs) are members of this institution.

The Pandemic Crisis Support

After being employed during the 2011 sovereign debt crisis, ESM assistance now plays a crucial role as part of a comprehensive plan designed by the European institutions to address the Covid-19 crisis.

Specifically, in April 2020, in the middle of the first wave of the COVID-19 pandemic, the Eurogroup agreed on creating a new instrument based on the ESM aimed at helping EAMSs finance healthcare-related expenses related to the pandemic, called “Pandemic Crisis Support” (PCS).

The PCS allows any EAMS to request, by the end of 2022, credit lines that will be set up with standardized terms and made available in as little as 2 months, for a maximum amount of 2% of the country’s 2019 GDP. They will have a maturity (repayment period) of up to 10 years.

PCS credit lines are particularly advantageous primarily because ESM enjoys the highest credit rating (AAA) and is thus able to finance itself on the market at very low, even negative, interest rates. These rates, as agreed by the Council, are then passed on to the EAMS with some fees, although lower than those that are usually charged.

In the graph below you can see the current interest rates required by investors to loan funds to each of the 19 euro-area governments for 10 years, together with the current estimated ESM/PCS rate when all fees are taken into account.

If you are discouraged by seeing all these numbers, bear with me for a moment while we undergo a concrete simulation to understand how the PCS can help.

Let’s take Italy as an example. Let’s assume Italy would like to raise debt to finance its hospitals for €35.8 billion (roughly 2% of its GDP), with a payback time of 10 years. At current rates, by financing itself on the market, after 10 years Italy would have to pay back €38.5 billion (the original €35.8 billion plus €2.7 billion in interest). If, instead, Italy financed itself through the PCS, after 10 years it would have to pay back only €34.9 billion, less than the amount originally borrowed! The PCS thus guarantees a total saving of €3.6 billion over 10 years compared to the self-financing option.

You can clearly see the advantage for countries currently paying positive interest on their debt (Greece, Italy, Cyprus, Malta, Spain, Lithuania, Portugal): they not only would not have to pay any interest on the amount borrowed, but they would actually get paid from investors to borrow money from them!

Still, even countries with a negative interest rate but higher than the PCS’ one (Estonia, Slovenia, Ireland, Latvia) would benefit from these special credit lines, as they would be able to pay back even less of the amount borrowed than what they would on the market.

Here below you can find a table with estimates on how much each country would be able to save over 10 years using PCS compared to the self-financing option, assuming they decide to borrow the maximum amount and fix a maturity of 10 years.

Countries on the graph that are on the right of the ESM, instead, would not benefit from ESM support as they can already finance themselves on the market at lower rates.

An additional benefit of PCS is that, even if a country applies for a credit line, funds do not necessarily have to be drawn because credit lines are designed to be a protection or insurance. What’s the harm in having this additional safeguard at one’s disposal?