Euro zone mulls cheap loans as incentive for economic reforms

Euro zone states are considering cheap loans to member governments as an incentive to carry out painful economic reforms, according to an EU discussion document on fiscal transfers.

The proposal does not specify how exactly the loans could be financed, mentioning only a European Commission idea from March that it could be either through direct contributions from governments or through designating a new revenue source.

The document, prepared by the chairman of European Union leaders Herman Van Rompuy, will form the basis of discussions between senior euro zone officials at a meeting in Brussels on Wednesday to prepare for next month's European Union summit.

The loans would be part of so-called contractual arrangements, which would be legally binding contracts with economic reform targets and milestones that trigger the payout of tranches of the agreed loan.

The loans would be offered at interest rates below those in financial markets. In that respect, they would amount to a degree of subsidised lending, ultimately amounting to a mutualising of risk among involved member states and a degree of financial transfer - an idea that Germany has long resisted.

A mechanism for fiscal transfers would move the euro zone a step closer to a fiscal union, especially if the mechanism of loans for reforms were to form the nucleus of a euro zone budget, so far only cautiously referred to by policymakers as the euro zone’s “fiscal capacity”.

It is not clear what time-frame the loans would be offered for, or what the limit on the size of any loan would be.

The loans would not be available to countries running excessive economic imbalances or currently under a bailout. However, an official briefed on the document said a country like Ireland could, for example, request a contract and if approved, benefit from the cheap loans.

While there were no details on how the loans could be financed, one possibility, the official indicated, might be for the euro zone’s rescue fund, the European Stability Mechanism, to raise money on international markets and on-lend capital to a contracted member state, although the exact framework and process of the lending is yet to be finalised.

Euro zone officials said that the lack of clarity on financing was the main weakness of the proposal and that discussions on it could only move forward once the issue was clarified.

“The proposal as submitted is hardly acceptable as it lacks clarity on how you finance such an instrument,” one senior euro zone official said.

“How are we going to finance this? From the EU budget? Because these won’t be small amounts ...” the official said, also pointing to the rise in public debt that such loans would entail.

Reuters