Global Daily – Evaluating options for the European Recovery Fund

by: Aline Schuiling

Euro Macro & Rates : EU leaders will discuss the European economic recovery package today, as was agreed during the Eurogroup videoconference on April 9 (see here) after extensive discussions. The ESM, EIB and SURE initiatives are likely to be rubber stamped, however making the future Recovery Fund more concrete will involve much more discussion. Several EU leaders have come up with proposals for the shape of such a European Recovery Fund. We outline and evaluate them below. The key features are set out in the table.

European Commission (EC) ‘Mothership’ Proposal – EC President von der Leyen has advocated the Multi-year Financial Framework (MFF) for 2021-2027 as playing the role of the ‘mothership’ of EU recovery. By temporarily increasing the amount the EU can raise from its members to create headroom in the EU budget, she plans to free up funds that can serve as guarantee to create financial leverage. The EC suggests a European Recovery Fund of at least EUR 1 trillion. This could involve, for instance, a total of EUR 100bn of upfront payments (over a two-year period) by member states, with the EC then issuing bonds. One minor footnote is that member have already been fighting over the new MFF for about two years, and this would complicate discussions further.

The French ‘Eurobond’-backed solution – France’s proposal is for a recovery financed by Eurobonds, a word that EU leaders on April 9 explicitly agreed not to mention in their statement (as it is so strongly opposed by some of the northern member states). France proposes to raise common debt with ‘joint and several’ guarantees so that all members are liable for the whole of debt issued, but it also signalled openness for partial liability. The French government lists some differences with the traditional view of Eurobonds: the proposed focus on future investments, the relatively temporary nature, and allocation via grants instead of loans.

The Spanish ‘Compromise’ plan – The latter themes are also reiterated by Spain, whose proposal is based on the issuance of perpetual debt under the MFF umbrella. Whereas France suggests member countries service the debt according to relative GDP, Spain suggests interest repayments should rely mostly on a new set of European (climate-related) taxes.

Agreement in the near term unlikely, but more possibilities later on – We deem an agreement on the shape of the European Recovery Fund at tomorrow’s call to be unlikely. A concrete and detailed plan still needs to be worked out and there are still many disagreements between member states. France and a number of Southern European member states are searching for ways to avoid increases in their debt burdens, to spread out the cost of economic recovery over a long horizon, and make debt servicing costs as light as possible. On the other hand,  a group led by Germany and the Netherlands want to uphold restrictions to avoid fiscal indiscipline and ensure repayments. In any case, the fund will have to be big, temporary and readily available. Compromise will be the key word here, but it may take EU leaders a while to realise that.

However, the contours of an eventual agreement might be falling into place, with Germany and Italy recently showing some flexibility. Germany this week signalled openness to use additional debt instruments for the European Recovery Fund, perhaps slightly increasing the odds for an agreement. And despite the Netherlands and Germany long resisting increases in their contributions to the EU budget, Merkel signalled openness to link recovery funds to the MFF, which might be increased. Meanwhile, Italy has shown openness to other instruments than Eurobonds. Italy is open for the MFF framework, and emphasizes the funds should be large, immediately available, in line with EU treaties and without conditions. While a Eurobond-based solution is unlikely, a hybrid plan based on leveraging an enlarged an MFF is a possible way forward. (Floortje Merten)

Euro Macro: Germany’s government presents its post-corona 2020 budget – Germany’s Finance Ministry published its new projections for government finances in 2020 today, which includes the impact of the outbreak of the coronavirus and its consequences for the government’s budget balance and debt ratio. The government plans a total fiscal impulse of EUR 1273bn (equal to more than 35% of German GDP). Of this total amount, EUR 820bn (around 25% of GDP) will be state guarantees, which should not have an immediate impact on the government’s budget deficit or government debt. The remaining EUR 453bn will be a fiscal impulse aimed at fighting the consequences of the coronavirus. It consists of total extra net spending by the central government (EIR 156bn), a newly founded special fund that will give financial support to companies – the so-called WSF (EUR 200bn), extra spending by regional governments (EUR 65.2bn), local governments (EIR17bn) and social security (EUR 15bn). This total amount is partly due to new discretionary policy initiatives (such as tax measures, income support for households and extra investment in health care), as well due to the cyclical deterioration in the economy (spending on unemployment and lower tax revenue) and also contains some elements of liquidity support (part of the WSF fund). According to the government projections, the total government budget balance will deteriorate dramatically this year, from a surplus of 1.4% GDP in 2019, down to a 7.25% deficit in 2020. Meanwhile, the government debt ratio is expected to jump higher, from 59.8% GDP in 2019, up to around 73% in 2020. The expected extra net borrowing by the Bund amounts to EUR 156bn in 2020 and that by Länder EUR 65bn. (Aline Schuiling)