EU: Hashing out a Recovery Fund

Published on April 23, 2020

European Union leaders will task their finance ministers in a videoconference today to make operational by June 1 a three-pronged, half-a-trillion euros fiscal package agreement reached on April 9 to help backstop sovereigns, businesses, and individuals hit by the COVID-19 crisis.

That package will set up a new standby credit line from the European Stability Mechanism (ESM), expand the lending capacity of the European Investment Bank (EIB), and provide EU-backed loans to member states to subsidize workers for lost wages, mirroring Germany’s “Kurzarbeit” employment scheme (see SGH 4/2/2020, “EU: A Three-pronged Fiscal Package”).

** But more crucially, especially as a political signal, the EU heads of state will also ask the European Commission today to produce a proposal for a Recovery Fund that is being closely watched by markets. We expect the deadline for submission of that proposal to be set for perhaps the end of this month, or soon after.

** The intent of the Recovery Fund is to create a jointly financed, massive pool of money available to all EU countries over the next few years to ensure that the economic rebound from the 2020 COVID-19-induced recession will be more even across the bloc, irrelevant of the wildly divergent public debt levels member countries will end up with after the pandemic. It will be up to the Commission to propose the size of the fund, but it is already clear we are looking at 1 trillion euros at a minimum, possibly more.

** As we first broke two weeks ago, one of the options the Commission is considering is to borrow on the market perhaps 100 billion euros a year, against the security of the next long-term EU budget for 2021-2027 (which would have a suitably increased “headroom” – with EU governments guarantees to pay if needed). That sum would then be leveraged 10 times every year and lent on to governments to finance investment over two to three years after the pandemic ends (see SGH 4/9/2020, “EU: The Debt Mutualization Wars”).

** Whether this will be the final proposal is hard to say, because the Commission will base its project on the preferences and red lines that all the leaders will spell out on the videoconference today. But it is already clear that there will be a link in the proposal to the next EU budget (the Multi-annual Financial Framework, or MFF), not least of all because it will allow the Commission to solve another highly controversial issue — whether the recovery funds should be loans to governments, or grants.

** Spain and Italy, worried about their already high debt levels spiraling out of control this year on all the coronavirus borrowing, insist all aid be provided as grants. The IMF is forecasting Italian debt to surge 21 points to almost 156% of GDP this year, Greece is to top 200% of GDP, and Spain could go up to 113% of GDP. But for the traditional “frugal” camp of Germany, the Netherlands, Finland and Austria, grants are a no-go.

** We are told a compromise might therefore be to provide grants that would come directly from the EU budget, while loans would be provided through the Recovery Fund — both sources of money working hand in hand and in coordination.

** Any other form of debt mutualization remains off the table, as are ideas for perpetual bonds, or annuities, such as that proposed recently by Madrid.

** The Recovery Fund saga is still likely to take some more time, with final decisions expected by June, under an optimistic scenario. And it might realistically take longer because of the linkage of the Recovery Fund to the MFF — the EU long-term budget is notoriously difficult to agree to, and as the saying goes “nothing is agreed until everything is agreed.”

** But the EU will get there, even if at a slower pace than markets would like to see, and under a much “lighter” mutualization structure than political analysts may like to see, not least of all because even the “frugals” have a political interest in a single EU market that is intact and working, rather than increasingly fragmented by diverging growth, unemployment and productivity rates.

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