Europe's leaders may soon have to bow to market pressure by issuing a common eurozone bond as early as next year, as a growing field of investors and economists say it would be the best – and perhaps only – way of solving the debt crisis.
French and German leaders disappointed financial markets this week, signalling that a common sovereign bond, if it ever comes, would be a long way off and that instead they were focusing their efforts on more economic integration.
But a Reuters poll of economists taken this week suggests Europe's power brokers will have to face up to the reality that jointly-issued debt might be one of the few measures that can stem the sovereign debt crisis, which threatens to overwhelm some of the bloc's biggest economies.
Some 41 out of 59 economists polled said a common eurozone sovereign bond would be a good long-term solution to resolving the crisis, with 36 out of 60 analysts expecting eurozone leaders to eventually agree to its issuance.
A majority of those analysts expected the first issuance as soon as 2012 or 2013, the poll showed.
"It is now make or break. It is either a march towards issuing joint bonds or the whole thing falls apart and sinks," said Russell Silberston, head of global interest rates at Investec Asset Management, who manages $31 billion worth of fixed income assets globally.
Fiscal integration a precondition
In theory, a common bond would allow highly indebted eurozone countries to regain access to commercial markets, while providing investors a safeguard through joint liability.
To prevent weaker euro zone countries from 'free-riding' on that common liability, analysts say fiscal integration or at least a more strict fiscal framework is necessary.
"One pre-condition for the introduction of common euro bonds is the access of the EU to budget controls in the countries," said Norbert Braems, chief economist at Oppenheim Research in Cologne.
That could involve an automatic mechanism to punish misbehaviour in national fiscal policy, or debt limits anchored in every country's constitution, he said.
French President Nicolas Sarkozy and German Chancellor Angela Merkel's plans for economic governance were seen as an essential first step towards eventual fiscal integration within the single currency area, which many in the market say is needed.
But implementation of such plans will take time and will do little to solve a more immediate issue: how weak eurozone members can secure funding over the long term.
Indeed, a median of 60 economists polled were not impressed with the response of European leaders to the crisis, rating it at four, with one being highly inadequate and 10 highly adequate.
With the European Central Bank having to buy bonds regularly in the secondary market to keep Italian and Spanish borrowing costs at affordable levels, and with the market having recently turned on France – the euro zone's second largest economy – analysts see some medium-term solution as increasingly urgent.
"Sometimes the market is the discipline of policy which often is behind the curve," said Matteo Regesta, a rate strategist at BNP Paribas. "The euro bond would be a very good idea, because it would mean a significant move towards fiscal integration: that we need."
Some prominent politicians in Europe, including Italy's Economy Minister Giulio Tremonti and Britain's Eurosceptic Finance Minister George Osborne, have come out in support of common eurozone bonds.
Enhanced EFSF a first step
In some ways, the euro zone is already on the path of joint debt policy, with its European Financial Stability Facility (EFSF) rescue fund, which is guaranteed by all eurozone countries and which has already issued bonds.
Once national parliaments approve its new mandate, the €440 billion EFSF will be able to give precautionary loans on strict conditions to countries under attack on bond markets, buy sovereign bonds on the secondary market and lend governments money to recapitalise banks.
Those new powers could make it very likely that the fund will eventually need a capital boost, especially if Spain and Italy one day require a bailout.
That would shrink the fund's capital pool, making it more difficult for it to carry out its bigger mandate.
A common euro bond could be issued by a single European debt management office on behalf of all eurozone issuers and could prevent markets from "attacking" bonds of particular countries.
Investors could ask for a premium to hold the bonds initially and these may need credit enhancements to secure a triple-A rating. But eventually they may substitute national issuance, maximising liquidity and making them attractive alternatives to the likes of US Treasuries.
Proposals for a boost in the rescue fund or even a common euro bond will inevitably face political opposition, especially from Germany. The Ifo Institute, a German economic think-tank, has recently estimated that eurobonds could cost the German taxpayer up to €47 billion a year, making it politically hard to sell for Chancellor Merkel.
But there is a growing view that the euro zone's paymaster will eventually agree to common issuance.
A common bond "would mean a significant move towards fiscal integration: that we need," repeated Regesta from BNP Paribas. "We have a monetary policy but we don't have a united, single fiscal policy, and that's why we are under stress now in the periphery."
EURACTIV with Reuters