Euro Macro Rates: EC plan is sizeable and focused on those in need – The European Commission presented a proposal for the MFF 2021-2027 yesterday, including a structure for a EUR 750bn European Recovery Fund. We find the plan credible and it would have a significant impact on the economic outlook if it stays in its current form. Despite the size being smaller than previously suggested, we find the amounts are sizeable and will be heavily skewed towards the economies hit hardest by the Covid-19 shock. The key question is what the plan will look like following negotiations between member states, as the proposal requires the unanimous approval of all 27 EU countries. There is a clear risk that it will be watered down.
The recovery instrument named Next Generation EU will raise EUR 750bn by borrowing on the capital markets. These EU bonds, of which the bulk will be issued between 2021 and 2024, will vary in maturity between 3 and 30 years and most of the amount will be paid back between 2028 and 2058 from future EU budgets. Of the EUR 750bn recovery instrument, EUR 250bn will be spent as loans to Member States to finance public investment, and have to be repaid gradually over 20 years by the beneficiary Member State. EUR 451bn will be spent as grants across the EU27 and EUR 49bn will be used as guarantees for the European Fund for Strategic Investments (EFSI) and InvestEU. The use of these investment vehicles is aimed at mobilizing larger financing volumes by attracting private investment, multiplying the guarantee by an expected factor of 1.5.
To create the required budget capacity for Next Generation EU, the EC suggests a temporary increase of the own resources ceilings by 0.6% GDP, on top of a permanent own resources ceiling of 1.4% proposed on the account of Brexit and economic uncertainties, to 2% of EU GDP. This means that Member States’ commitments, and thus the amount of contributions that can be called upon by the EC, increase. This headroom serves as guarantee for the borrowing. Furthermore, the EC proposes a number of new sources of revenue that could also be used for repayment, which could lower the future burden on member states. One example is a digital tax on companies with an annual global turnover above EUR 750bn or an own resource based on operations from companies that draw huge benefits from the single market.
The table below shows the allocation of grants, loans, and funds under EFSI/InvestEU, for the EU27, the eurozone and the Big-6. The total package of EUR 750bn amounts to around 5.8% of total EU GDP. As can be seen, the allocation of funds is heavily skewed towards Spain and Italy. Under the EC proposal, Spain and Italy receive an allocation of 19.9% and 20.4%, respectively. Total funds for Spain amount to 13.1% GDP, while they amount to 9.4% of GDP for Italy.
The recovery plan will lead to a significant boost to economic growth, especially given that it is intended that the stimulus is front-loaded. The European Commission estimates that for the EU as a whole GDP growth will by 2.3% higher by the end of 2024, which we think is a credible estimate. Much of that (1.8%) would come next year. Meanwhile, the economic growth impact for Italy and Spain would obviously be larger given the scale of the stimulus is considerably more relative to the size of their respective economies. The EC also estimates that as a result government debt ratios will be lower than they otherwise would be. However, crucial for the medium-to-long-term debt outlook in the case of Italy is improving the country’s trend growth rate, which is close to zero. Although it is clear such a fund would give a cyclical boost to the economy, whether higher growth lasts beyond the next 2-3 years is debatable. (Floortje Merten & Nick Kounis)