Because no nation wants to use the ESM. Banca Generali-Saxo Bank Report

Because no nation wants to use the ESM. Banca Generali-Saxo Bank Report

The analysis by Althea Spinozzi for the BG Saxo study center ( Banca Generali and Saxo Bank)

The ESM (European Stability Mechanism) is an obsolete mechanism and endangers the sovereignty of the members of the European Union. Dilution risk, rising government refinancing costs and stigmatization are some of the threats that countries that use them would face to obtain funds at a lower interest rate. European nations should raise funds on the capital market rather than ask for a loan from the ESM.

The ESM has separated the opinions of citizens. On the one hand, many wonder why a European nation should not take advantage of the opportunity to finance itself at low cost with the ESM. On the other hand, it should be specified that this is not a charity activity in support of the most needy, but it carries out a profitable activity, like a normal bank and grants low-cost loans in exchange for taxes and economic commitments.


To understand why European nations are deciding not to access the Mes it is necessary to understand how it works in detail.

First, the ESM grants funds only for Covid-19 related expenses that have already been incurred, which means that a nation must first increase its fiscal deficit in order to apply for a loan.

Subsequently, the maximum amount that a nation can request is equal to 2% of the GDP of 2019. In the case of Italy, given that the GDP of 2019 was about 1.8 trillion euros, it could ask for a loan from the Mes for about 36 billion euros. In addition, it is not possible to receive the entire sum directly at the beginning, but the Mes provides for several tranches for the duration of about 7 months, as it is possible to receive only up to 15% of the loan amount at a time.

Italy could not ask for 36 billion euros of funds as it has not spent this amount to deal with the Covid emergency. So far, according to data from the Ministry of Economy and Finance, Italy has allocated 9.5 billion euros for investments in the health system. Furthermore, the expenses attributable to national health services in 2019 amounted to approximately 114 billion euros , which makes it difficult for Italy to demonstrate that 30% of the health budget is exclusively allocated to expenses related to Covid-19.


The funds of the ESM cannot be compared with sovereign debt for the same logic for which one could not compare the costs of a home loan with those of financing for the purchase of a car. Below, an explanation of the main differences and why European nations should raise funds on the capital market.

ESM funds are senior with respect to sovereign credits . This leads to a dilution risk, which can adversely affect the debt structure of the calling nation. In practice, this means that to receive 9 billion euros of funds, Italy must change the structure of the debt repayment, giving priority to the ESM to the detriment of sovereign creditors, who would require higher yields on bonds given the entry of new creditors to be repaid before them. Therefore, the compromise of receiving 9 billion euros at a low interest rate, causing a repricing of 2 trillion euros of Italian government bonds, is not only expensive but also disadvantageous.

The ESM imposes conditionality, the sovereign debt does not. Contrary to what happens on the capital market, by accessing the Mes, a nation is placed under special surveillance to ensure that the debt is repaid. This implies the application of a series of economic and fiscal conditions that ensure repayment at maturity.

The interest rates on the ESM are variable and depend on the funding scheme of the program. For example, Spain had resorted to ESM loans in 2013 at a rate of 40bps but managed to pay up to 100bps in 2014 because the ESM financing strategy moved from issuing short-term to long-term securities. term . When Italy issues BTPs, it can choose a convenient deadline and the cost of financing, which it could not do with the ESM.

The use of the ESM could make it appear that the nation is financially unstable, providing a distorted picture compared to the Italian situation. Italy can access the capital market without problems and has no refinancing problems.

This is also why the costs of the two types of financing are not easily comparable. The only way to evaluate the convenience of the ESM would be to compare it with securities with the same degree of risk. So, in conclusion, a country would be willing to pay its debt more rather than pay the price of stigmatization.

At the moment, Italy can raise funds at the lowest rate ever seen in history: negative interest rates for bonds with a 3-year maturity and 12bps for bonds with a 5-year maturity. On 22 October (the day before the article was written), the country issued 8 billion euro of BTPs with a maturity of 30 years, for which it received orders for 90 billion euro. It is definitely not showing financial instability and is raising a lot of liquidity.

In this context, Mes funds are very similar to Snow White's apple: with a perfect shape and color but poisoned. From our point of view, it is clear that the ESM is an outdated tool created for nations in financial difficulty during the 2012 banking crisis.

Suppose the European counterparts really want to provide profitable financing to support the countries most affected by Covid-19. In this case they would have to reformulate the structure of the ESM, such as, for example, accepting the same degree of subordination as the outstanding securities. However, issues related to stigmatization would remain one of the problems for a country's financing costs, making the ESM still impractical.

With the new wave of coronavirus hitting Europe, the EU may have no alternative but to issue joint debt instruments and get rid of such an outdated instrument.

This is a machine translation from Italian language of a post published on Start Magazine at the URL on Mon, 09 Nov 2020 14:30:36 +0000.