EU: Recovery Fund Talks

Published on July 10, 2020
SGH Insight
*** But the challenges in coming to an agreement by then were already clear after a June 19 summit produced little progress in EU negotiations with the “Frugal Four” holdouts of the Netherlands, Sweden, Denmark, and Austria. More importantly, it appears there is still broad support from all sides to show concrete progress at the upcoming meeting to keep negotiations on track for a final agreement, perhaps even as widely hoped for by the end of July.

Market Validation
(Bloomberg 7/20/20)

The euro climbed to a four-month high, European bond spreads narrowed and stocks rose as leaders made progress in negotiating a historic stimulus package. U.S. equity futures were mixed with the S&P 500 coming off a three-week rally.
Italy’s 10-year bond yield spread over Germany, a key gauge of risk in the region, fell to the lowest level since March.
In Europe, leaders appeared close to reaching an agreement on a rescue package. The four governments that have been holding up negotiations are ready to agree on a key plank of the deal, two officials said. The Netherlands, Austria, Denmark and Sweden are satisfied with 390 billion euros ($450 billion) of the fund being made available as grants with the rest coming as low-interest loans, the officials said, asking not be named discussing private conversations.

European Union officials have been close to unanimous on one point regarding the ongoing 750 billion Euro “Recovery Fund” negotiations, and that is to downplay expectations for an agreement at the upcoming heads of state special European Council meeting that is slated for July 17-18.

*** But the challenges in coming to an agreement by then were already clear after a June 19 summit produced little progress in EU negotiations with the “Frugal Four” holdouts of the Netherlands, Sweden, Denmark, and Austria. More importantly, it appears there is still broad support from all sides to show concrete progress at the upcoming meeting to keep negotiations on track for a final agreement, perhaps even as widely hoped for by the end of July (see SGH 6/19/20, “EU: A Slipping Negotiating Box”). ***

In a compromise proposal presented today, European Council President Charles Michel, who as chairman of the summit was tasked with putting a “negotiating box” on the table, did not drop the proposed 750 billion fund size – even the most frugal of the EU states appreciate the importance of keeping this headline number intact as a confidence signaling device.

More to the point, over the objections of the hardliners, Michel also kept the ratio of grants to loans at 500 billion and 250 billion euros, respectively. Despite their prior objections, however, EU hardliners appear to have softened up on their resistance to the preponderance of grants versus loans — recall that the grants are being sold as a one-off temporary crisis measure, and thus not to be confused with the dreaded “debt mutualization.”

Rather, the sticking points are around “governance:” how and how much conditionality to attach to the grants; some hard-nose negotiations led by the Netherlands to protect rebates in the seven-year EU budget that are set to expire, and; some adjustments to how the Recovery Fund money is to be doled out.

In a largely symbolic nod to fiscal rectitude, Michel’s proposal will look to tweak the 2021-27 EU “Multiannual Financial Framework” (MFF) budget to 1.074 trillion euros, somewhere above the original 1.050 trillion euros and the European Commission’s more aggressive 1.094 trillion euro proposal – a downward adjustment from the EC proposal that, spread over seven years and twenty seven countries, markets will not care about.

In a more substantive, but fully expected, cave-in, Michel also proposed that all the rebates in question for the Netherlands, Germany, Denmark, Austria, and Sweden that were set to expire be maintained in full. Nothing, after all, works as well as spreading the love around.

On the issue of conditionality, Germany’s Chancellor Angela Merkel was careful to stress the need for reforms to accompany any grants before meeting this week with Dutch Prime Minister Mark Rutte. But what Rutte appears to have had in mind was more aggressive, namely to require unanimous approval of any individual aid recipient country’s budget by the EU 27.

A veto from any single country over how Italy, or say Portugal, get to spend aid money is highly unlikely to fly, and a much softer “qualified majority approval” based on Commission recommendations is far more likely, and that is what Michel has proposed. But conditionality will still need to be hammered out.

Michel has also proposed changes to how aid money is to be allocated, addressing objections from member states that, for example, under the old proposal Portugal would receive the third largest disbursement from the Recovery Fund despite having experienced the smallest recession in the EU.

Michel’s proposal is to split the 750 billion-euro fund into a 70%-30% tranche. Over the first two years of the three-year Recovery Fund plan, 70% of the 750 billion euros would be allocated under the Commission’s original, and more controversial, criteria, which leans heavily on each country’s unemployment rate over the last five years.

In the third year, meaning in 2023 (the fund is not set to kick in until 2021), the remaining 30% would be allocated based on a different set of criteria, where historic unemployment would be replaced by the severity of the decline in each member state’s GDP in 2020 and 2021, numbers that would be made available by Eurostat by mid-2022.

With Michel having, as tasked, laid out a “negotiating box,” the ball is now back in the leaders’ hands to hammer out the final deal. Of course, even under the best of circumstances none of the funds would be available until 2021, and hence the urgency to strike a deal as soon as possible.

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