The incoming Commission, as reported here, seems to be critical of the idea of funding its 300 billion European Investment plan by an additional capital increase of the European Investment Bank (EIB).
It is right to be sceptical. Indeed, the experience with the Growth Compact of June 2012 is a bit sobering. Whereas the 10 billion of new capital that member states provided to the EIB by the end of 2012 was supposed to lead to an additional lending volume of 60 billion, the outstanding amount of loans disbursed by the EIB has thus far increased only by 15 billion only (see EIB 2013 financial report). In other words, the big accelerator effect on investment that the EIB was supposed to deliver under the 2012 Growth Compact has not materialised.
The Problem with the EIB: Depending too much on the markets
To explain why the EIB is currently finding it difficult to function as an investment accelerator, let’s first recall how the 2012 Growth Compact was supposed to work. Member states were asked to put up initial capital of 10 billion. The EIB would then use this capital to borrow an additional 50 billion in the market. The 60 billion thus obtained by the ECB would then be topped up with a corresponding amount of co-finance by the EIB’s (public and private) investment partners. In this way, a grand investment total worth 120 billion or close to 1% of European GDP was envisaged.
This, at least, was the theory. In reality, however, things did not turn out that way. The problem already started with the 10 billion member states had to make available. Member states needed to borrow that money from financial markets. Having the euro crisis on their mind, governments were however reluctant to do so as this implied further increasing their exposure to fickle financial markets.
The same problem of depending on the judgment of markets returned at the level of the European Investment Bank. The EIB is owned and financially backed up by the member states themselves. With markets questioning the sustainability of the sovereign debt of several member states, doubts have also been raised about the creditworthiness of the European Investment Bank itself. Concerned about its triple-A rating, the European Investment Bank is therefore tempted to use the new funding so as to strengthen its own capital base rather than borrowing a multiple of this new capital.
Problematic market finance reappears again when co-finance is concerned. To reach a grand total of 120 billion investment, member states needed to borrow an additional 60 billion from the markets (and this on top of the extra 10 billion capital for the EIB). This may be possible for the financially stronger member states but it is extremely difficult for the rest of them. The irony here is of course that the latter need this extra investment push the most.
It thus appears that the implementation of each stage of the 2012 Growth Compact is very much dependent on the judgment of financial markets. And given the current complex relationship between member states, the EIB and markets, it does not come as a surprise that the 120 billion of new investment never really took off.
Will a Collaterized Debt Obligation do the trick?
While the Commission seems to be admitting that a new capital increase for the EIB will not do the job, it is also doubtful whether its alternative proposal of launching a 300 billion Collaterized Debt Obligation (CDO), including a buffer of 30 billion from the European budget to cover possible losses, will really solve much.
Indeed, the CDO proposal suffers from the same problem of relying too much on the markets. When launching its European CDO, the Commission, just like the EIB, will not be immune from market pressure. The Commission will also be keen to obtain a high credit rating since the latter is key to low interest rates as well as to ensure the liquidity of the CDO.
The consequence may very well be that the Commission will go down a similar path as the EIB. To prop up the credibility of its CDO in the markets, the Commission may be forced to reduce the total amount of its investment plan as well as to shift the focus away from member states that are in the greatest difficulties towards those member states not considered to be a risk by the markets.
From ‘Credit Easing’ to ‘Investment Easing’
In the end, things boil down to the question whether we allow markets the power to define and shape the European Investment plan. If yes, the EIB experience will be repeated over and over again and any investment plans that are launched will be scaled down so as to meet the concerns of the markets.
If the answer is no, then the only actor that has the ability to manage market sentiment and steer markets into the right direction needs to step in. To end the monopoly of financial markets in deciding which Euro Area member states deserve access to finance and which do not, the ECB needs to back, with its full weight, the European Investment Plan. It can do so by systematically buying sufficiently large quantities of this CDO (or any other form of European Growth Bond), in that way keeping interest rates low as well as ensuring an adequate volume of finance.
This perfectly matches with the deadlock now existing in the Euro Area’s monetary policy. On the one hand, the ECB is confronted with a Euro Area economy that is suffering from depressed growth and is on the brink of deflation. On the other hand, the policies the ECB has been trying for the past years are not really working: policy interest rates have been lowered but have now reached the zero lower bound and can’t be cut any further. Also, the ECB has massively used its printing press, handing over a trillion Euro of almost free money to the banking sector in the vain hope that the banks would extend more credit to the real economy. However, this ‘credit easing’ has failed to revive aggregate demand, as is clear from the dismal growth performance of our economies over the past years.
This implies that it is time to go for alternative, non-conventional, ways of quantitative easing. Instead of putting even more cheap money into the banks (‘credit easing’), the ECB should go for ‘investment easing’ and directly provide the finance that a European Investment plan, an initiative that is urgently needed to get our economies out of the slump.
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