EU: The Recovery Fund Plan

Published on May 28, 2020

The European Commission rolled out a proposal yesterday for a European Union Recovery Fund that would borrow 750 billion euros against the Commission’s triple-A rating, securitized by the 2021-2027 EU budget, to help pull Europe out of its deep, COVID-19 pandemic recession.

Intended as a compromise between a 500 billion Euro “Merkel-Macron” grants-only plan that is championed by the heavily indebted member states of the south, and a loans-only counterproposal from a “Frugal Four” coalition of the north, the EC plan puts both on the table, proposing that 500 billion euros be disbursed over 2021-2024 in the form of grants, and 250 billion euros in the form of cheap loans.

On its face, simply slapping the opposing camps together may seem like a curious way to compromise, particularly as hardline states have continuously expressed their strong opposition to the EU-wide provision of grants to member states.

** But the off-ramp for these and other member states that remain firmly opposed to the mutualization of EU debt is that grant provisions in this proposal will be presented as a “one-off” crisis payment, as opposed to an open-ended transfer union.

** The politics are clearly now favorable towards reaching a deal along these lines, as even the most fiscally conservative EU member states are not ready to block a Recovery Fund in this, Europe’s dire moment of need, especially with the weight of Germany behind the plan.

** And so even as arduous negotiations over final size and composition, conditionality, and how to tax and pay for it all play out, political opposition to grants will not prove a death knell to the Fund, in contrast to the more open-ended mutualized “Coronabond” idea that was categorically ruled out by Berlin, among others, earlier this year.

More contentious will be the nitty-gritty of getting agreement and national parliamentary approval of some of the Commission’s suggestions for additional EU-wide taxes that will be required to pay for the grants.

Spending the Money

The Commission proposes that the two countries worst hit by the pandemic, Italy and Spain, receive a lion’s share of the fund; Italy would get 173 billion euros out of the 750 bn total (82 bn in grants and 91 bn in loans), and Spain would get 140 bn euros (77 bn in grants, and 63 bn in loans).

In addition, the other high-debt southern European countries, and France, would get generous shares of the pie; 39 bn in grants only for France, 23 bn in grants and 9 bn in loans for Greece, and 15 bn in grants and 11 bn in loans for Portugal.

The 750 billion-euro Recovery Fund will be combined with the 2021-2027 Multiannual Financial Framework (MFF) EU budget that the Commission has proposed be set at 1.1 trillion euros (see SGH 3/22/20, “EU: More Fiscal Flooding”). The total sum of 1.850 trillion euros has thus been advertised by the EC as stimulus to get the European economy going, which is a bit naughty as the 1.1 trillion would have been in the budget regardless, COVID or no COVID.

The 750 billion euros would nevertheless come on top of the three-pronged 540 billion euro stimulus package of loans for the short-term work scheme, stand-by credit for governments, and guarantees for companies that was agreed to earlier this year by the EU (see SGH 4/2/20, “EU: A Three-Pronged Fiscal Package”), and which is where the Commission gets the 2.4 trillion euro total figure that markets may have seen.

The Commission is proposing that disbursed funds be largely allocated towards financing Europe’s transition to a greener economy (slashing CO2 emissions and moving to sustainable energy sources), and to a more digital economy. The Commission, of course, would be scrutinizing these requests for funds.

Raising the Money

The 750 billion euro fund raise can be available only after the EU completes rather lengthy and complex approval procedures which, in the case of Commission borrowing, would require the politically tricky ratification by most EU parliaments of a temporary increase in government guarantees for the EU budget from the current 1.2% of Gross National Income (GNI), to 2.0% of GNI.

Once the money is raised, and disbursed, replenishment of the 500 billion euros the Commission wants distributed in grants is proposed to come from a series of EU-wide new taxes, but which now national leaders will have to approve – far from a done deal.

Taxes under consideration include a levy on non-recyclable plastics, on digital services, a carbon border adjustment tax on imports into the EU from countries with more lax CO2 emission standards, a share of the trade in CO2 emission permits for maritime and air transport, and a slice of the national corporate tax on large multinationals that benefit from operating within the EU single market.

Battling over Taxes

Agreeing on new taxes is an arduous and lengthy process in the best of times, and so the Commission has proposed that in the meantime it borrow funds for longer term maturities, including 30-year bonds.

On the near end, the Commission bonds it appears will be no shorter than for 7 years, ostensibly designed to coincide with the first repayments that are envisaged to come only after completion of the 2021-2027 budget term, starting in 2028.

Even then, Commission officials, from what we understand, expect the earlier maturing bonds to be rolled over to push repayments back, albeit no later, they say, than 2058.

Pushing Funds into 2020

The MFF and Recovery Fund will take time to negotiate, design, and push into the economy, starting in 2021, and so to pump stimulus into the economy this year, ideally by September, the Commission wants EU governments to raise their guarantees for the existing, expiring 7-year EU budget for the remaining six months of its tenure.

One of the Commission proposals is to then deploy 31 billion euros in a solvency support instrument that would serve as guarantees for the European Investment Bank to unlock a hoped for 300 billion euros in private investments into otherwise solvent European firms that are struggling from the effects of the pandemic and shut downs.

The Commission suggests another 15 billion euros go into a Strategic Investment Facility vehicle modeled after a former EU “Juncker Plan” investment scheme, meaning another ten times leverage scheme with the goal of unlocking 150 billion euros in private cash for EU firms.

It all goes without saying that the European Central Bank will, at this rate, be mopping up bonds for years to come.

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