Euro zone eyes ways to deploy its bailout fund in war with coronavirus

By Jan Strupczewski

BRUSSELS (Reuters) - Euro zone officials are considering how to deploy the unused firepower of the bloc's bailout fund to limit the economic damage wrought by the coronavirus epidemic, via a scheme that could pave the way for more ECB purchases of Italian bonds.

Italy is battling Europe's worst outbreak of coronavirus, which is spreading across the continent, including the 19 countries that use the euro.

The European Stability Mechanism (ESM) bailout fund was created at the height of last decade's sovereign debt crisis to be a lender of last resort to governments cut off from markets. It has 410 billion euros of unused lending capacity.

No euro zone government, including highly indebted Italy, is even close to losing market access, but some politicians believe that getting the ESM involved would reassure investors and help stabilise volatile government bond markets.

The brainstorming is tough because of established divisions between fiscally strict and less frugal euro zone countries and because the ESM does not have any instruments designed specifically for emergencies like the pandemic.

Two officials said an idea being considered is for all euro zone governments to apply for a stand-by credit line from the ESM to show markets they have serious money, if needed, to finance the challenge to their health systems and support crumbling economic growth.

A joint application would also remove the stigma for a single country, like Italy, of asking for help.

Italy's very high and rising debt makes it ineligible for a Precautionary Conditioned Credit Line from the ESM, officials said, meaning that countries would have to ask for an Enhanced Conditions Credit Line (ECCL). But the tougher conditions attached to the latter could make it politically less palatable for governments including Rome.

An ECCL scenario could allow the European Central Bank could step in with its Outright Monetary Transactions programme of unlimited sovereign bond buying, provided the ESM committed to buying government bonds on the primary market.

ESM funds could be distributed on the basis of the ECB's capital key, which would give Italy, the euro zone's third-largest economy, a very sizeable chunk of the money.

"In my mind, an ECCL would work for Italy," one senior euro zone official privy to the discussions said.

To make the conditions attached to the ECCL easier to swallow, they could be focussed on the specific challenges posed by the coronavirus, rather than encompass a general overhaul of the economy.

"If they insist on tax money from other countries without any conditions, that is in the end their responsibility," the official said. Nothing was being ruled out at the moment, he added "but in the end it will boil down to facts to support what the best way forward is."

(Reporting by Jan Strupczewski; Editing by Catherine Evans)