The coronavirus pandemic could exacerbate the EU's existing weaknesses, the European Central Bank (ECB) warned in a report on Tuesday. The bank warned that a looming economic crisis revive the threat of countries exiting the single currency.

"The increase in public debt comes on top of already higher debt levels in some sovereigns," ECB Vice-President Luis de Guindos said.

The ECB forecasts a rise in public debt as a share of output in the eurozone between 7% and 22% in 2020. The reason for the vast margin of error is the level of uncertainty both over debt and GDP levels: economic output is sure to shrink in most countries this year, just as government borrowing is sure to rise — and in both cases, it's not yet clear to what extent.

"A more severe and prolonged economic contraction than envisaged.... would risk putting the public debt to GDP ratio on an unsustainable path," prompting fears to "cascade" to the rest of the economy, the central bank warned.

The eurozone's formal target is for a country's debt not to exceed 60% of its GDP, although very few members were keeping to this even before the pandemic. Even Germany only ticked below the nominal limit for the first time in 2019, and is all but certain to stray back above it this year.

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More central borrowing the solution?

The ECB warned about the numerous countries in the EU that for years have put off addressing their mounting debts. But now that the pandemic is forcing countries to spend more on recovery efforts and attempt to keep their economies afloat, state debt is only growing.

This could increase the perceived "redenomination risk" among investors, the danger of some countries quitting the euro or the single currency collapsing altogether.

"In the medium term we have to pay attention to the fiscal sustainability situation," de Guindos added. 

One potential solution would be increased joint action at the European level, the bank said, which could keep government debt sustainable for individual nations.

More bonds from "highly rated European entities" rather than national capitals "will arguably reduce overall sovereign funding costs and, in some jurisdictions, decrease sovereign spreads," the report read.

"We hope that [a fiscal response] will not come only from national authorities, but that it will come as well from pan-European authorities," ECB deputy de Guindos said. "We hope that the decisions that will be taken by the [European] Commission and the European Council will go in that direction."

Last week, France and Germany presented a plan for the EU to jointly borrow 500 billion euros to help pay for rebuilding the economy after the pandemic, but encountered resistance from other members like Austria and the Netherlands.

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The European Commission is set to unveil its own proposals on Wednesday.

jcg/msh (dpa, AFP)

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