20 May 2020

The Franco-German bond to the rescue


Chancellor Merkel and President Macron have presented a joint Franco-German initiative for a €500 billion euro Recovery Fund to issue bonds and finance expenditure in the hardest hit countries and sectors.

Given the legal constraints on the EU budget, this can be achieved by increasing the so-called expenditure ceiling for the EU budget from approximately 1 to 2% of GNI for the next three years. This Recovery Fund proposal would enable additional expenditure of around €165 billion per year and would add up to €500bn over three years. The Fund would thus be integrated into the EU budget and in the first instance would finance expenditure in the healthcare sector, but potentially also underpin the green transition and provide help for the countries most affected by the current crisis.

The Commission had informally indicated that it was working on a much larger package, purportedly in the order of €1 000 to €1 500 billion. But the basis for that large number was supposed to be only about €300 billion in real money. The rest would have come from various leverage schemes. This new proposal might appear smaller at first sight – ‘only €500 billion’ but it is much cleaner and has more real new funding than what the Commission had been working on so far.

This Franco-German initiative constitutes an important political step.  France and Germany can only propose it to other member states, but since they effectively represent the two camps which had so far been locked in stalemate, it is unlikely that any other member state will block it outright.

On the substance, the Franco-German agreement combines two key elements already foreshadowed in previous CEPS contributions: first, a recourse to  Article 122 of the Treaty which explicitly foresees help to member states in exceptional circumstances, and, second, the use of the EU budget in the form of the next MFF, to help hard hit member states via grants, rather than providing them only with loans.

What makes the proposal attractive politically is that nobody has to pay now. Instead, additional expenditure will be financed with bonds, which do not have to be repaid over the lifetime of the next financial framework of the EU, i.e. not before 2028. The real fight over who pays for the additional ‘corona’ expenditure has thus been postponed. For the time being, no country will be forced to increase its contribution to the EU budget. This aspect will soften the opposition, also from the so-called frugal coalition.

The next EU financial framework can be easily imagined. Existing expenditure on agriculture and regional funds (much of it of dubious European value added) will more or less continue as before, as will the contributions to the EU by member states, in all likelihood. But the additional corona-related expenditure will be financed by debt instruments issued by the EU. These future EU bonds are not quite the same as the famous Corona Bonds that Germany resisted so strongly until recently. It will be the EU, as a Union, that will take on the debt – not the member states. There are already some small amounts of EU bonds outstanding, which are rated AAA – but mainly because the amounts are so small. It remains to be seen how financial markets (and rating agencies) will react to the EU now issuing €500 billion of them.  The details on what guarantees need to be given to ensure that investors buy this debt will occupy lawyers and rating agencies for some time. In the end, it will come down to the question of whether the markets see the EU as a viable political institution that can secure its own funding without having to rely on the ultimate guarantee of its strongest members.

Nothing has been decided or agreed yet, but this compromise opens the door to a great bargain between Europe’s North and South.  A bargain the East has little interest in torpedoing as long as it sees that its financial interests can be safeguarded.