Eurobonds and project bonds: telling them apart

(PARIS) - Advocates of spurring growth in Europe have put on the table two financial instruments -- eurobonds and project bonds -- which both entail joint borrowing but differ in detail and scale.

EUROBONDS

The creation of eurobonds has long been promoted by advocates of a more federal Europe. In short, eurozone member states would begin raise funds on debt markets by issuing so-called eurobonds, and would be collectively responsible for the interest due and for repayment of the amount borrowed.

Such joint debt, which the European Commission has repeatedly proposed, would offer several advantages.

First, it would shelter weaker eurozone member states from speculative attacks. Investors would no longer be able to dump or refuse to buy the debt of particular eurozone members causing concern because of weak economic performance.

Secondly, it would reduce the current borrowing costs of weaker states as markets would price the eurobonds based on a weighted average of eurozone countries. Thus Italy and Spain which are currently paying 5.5-6.0 percent annual interest to raise funds for 10 years would benefit from top-rated Germany which is paying 1.4 percent.

Thirdly, eurozone states which were forced to pay high interest would be enabled to refinance their debt.

However, introducing eurobonds also have downsides, in particular a reduction of incentives to maintain a balanced fiscal policy, which Germany among others never fails to point out. By having their borrowing costs reduced thanks to other eurozone states, those that need to reduce deficits and carry out difficult structural reforms would no longer feel the immediate pressure of markets through higher borrowing costs.

On a more practical note, countries such as Germany which have been paying ultra-low rates, would see their borrowing costs rise since strong countries would be pooling their strong creditworthiness with the poorer credit standing of weaker countries.

PROJECT BONDS

Project bonds, which have also been dubbed "baby eurobonds", would be bonds jointly issued by several or all eurozone states. But instead of the funds going to the national coffers for general use, they would be dedicated to a specific infrastructure project. Concrete assets would back the bonds in addition to the guarantees provided by the countries.

EU member states and the European Parliament are still working towards an agreement to launch project bonds on a pilot basis. With 230 million euros ($291 million) of seed money from the EU budget, a further amount of about 4.5 billion euros would be sought from private investors and the European Investment Bank to finance a handful of transportation, energy and high-tech projects.

Some see project bonds as a step towards the eurozone moving towards issuing eurobonds, especially if it continues towards becoming a fiscal union in which members would provide direct budget support to one another.

THE STATE OF PLAY

France's new President Francois Hollande raised for consideration both eurobonds and project bonds as part of his drive to get the eurozone to take action to boost growth. Italian Prime Minister Mario Monti also supports both tools.

Germany adamantly opposes eurobonds until eurozone states have repaired their public finances and enacted structural reforms to make their economies more competitive, and has repeated that position in the run-up to Wednesday's summit.

Berlin sees Paris as having proposed both in order to gain advantage in talks to obtain support for project bonds, while in Paris they believe Berlin is open to project bonds.