Euro Macro: We are sceptical whether the French-German plan is a huge leap forward – Since EU leaders on 9 April agreed to work on the set-up of a European Recovery Fund to complement the ESM, EIB and SURE initiatives, multiple member states came up with proposals for its shape. Yesterday, France and Germany published a common initiative for the ‘European Recovery from the Coronavirus Crisis’, which has been heralded as a game changer in many quarters. Although it is a positive to have the governments of Europe’s two biggest economies driving the agenda together, there is reason to be sceptical that the plan represents a game changer at this stage. There are a lot of unanswered questions. The European Commission is expected to publish a detailed proposal on May 27, and this could provide the clarity needed to increase our degree of confidence.
Size does matter – The plan envisages a fund of EUR 500bn, which would be in the framework of the next MFF (EU Budget), which runs from 2021 – 2027. The fund would represent around 4% of EU GDP, which is not a lot over a number of years, even if the intention is to front-load it in the first years of the MFF. Indeed, it is only half the size of the fund previously suggested size by France (EUR 1 trillion) and earlier indications from the European Commission (EUR 1 trillion or more). Of course a lot depends on the distribution.
Distribution unclear – The Recovery Fund will provide budgetary expenditure for most affected sectors and regions, and should be channelled through EU budget programmes. There will be a focus on investment in the green and digital transitions and research and innovation. However, the exact distribution and skew towards vulnerable economies is still not clear. If the fund was skewed towards a handful of EU economies, the impact in boosting economic growth (and hence also in some cases providing a much needed improvement to currently unfavourable long-term government debt dynamics) could be meaningful. However, that remains to be seen.
Grants versus loans – One of the reasons for the excitement following the German-French move was the idea that Europe would be essentially borrowing together and would give the beneficiaries grants versus loans. The former is for sure true, the latter is also unclear at this stage. The EU (or EU institutions) would borrow funds on capital markets to scale up the money available. So for instance with a multiplier of 10 (though it could be higher – see below) member contributions of EUR 50bn could allow for long-term borrowing of EUR 500bn.
However, it remains the case that the EU is only allowed to borrow to lend funds rather than to give them away. Indeed, EU revenues and expenditures under each year’s EU budget need to be balanced, meaning that, if the EC wants to increase expenditures during the first years of the MFF, it will have to finance those by increasing its own resources accordingly in that same year. The proposal mentions the set-up of a binding repayment plan ‘beyond the current MFF on the EU budget’, suggesting the funds will be allocated as grants, and gradual repayment will come from the EU budget and take place over a horizon of more than seven years. It is not clear how this could work.
EU focused on a number of programmes – Another uncertainty is exactly how the funds will be invested. On this issue we may get some insight from EC President Von der Leyen’s ‘Recovery and Resilience Facility’, where some details have been made available. The EC seems to be focused on strengthening a number of existing programmes, such as RescEU or Horizon Europe (focused on dealing with disasters, and research and innovation, respectively) and crucially InvestEU (the successor to the European Fund for Strategic Investments set up in 2015, where the EIB leveraged the EU guarantees with a multiple of 15x). These programmes might be the ones used to drive investment from the EU recovery fund discussed above. InvestEU encompasses repayable support to financing and investment operations, though admittedly it could be used as a complement to grant financing.
Political obstacles – After the EC presents a proposal for the new MFF, the European Council needs to agree unanimously, complemented by the European Parliament’s consent, in order to reach a deal. This means that the German-French plan would need unanimous backing by other member states to become a reality. Recent history is full of examples where an agreement between Germany and France leads to policy progress (with the northern states following the former and southern the latter). However, there do seem to be some member states that would oppose the proposal or at least only agree to a relatively watered-down version. The Netherlands, Austria, Sweden and Denmark might be the most difficult countries to get on side. (Floortje Merten and Nick Kounis)