Following a record 90‑hour negotiation, EU leaders agreed on July 21st on a €750bn (US$869bn) post-pandemic economic recovery fund and a 2021‑27 budget worth €1.07trn (US$1.24trn). The summit preserved the overall size and main elements of the European Commission’s proposal for a post-pandemic recovery fund, known as Next Generation EU, but the balance between grants and loans has changed slightly. In return for compromising on the recovery fund, the “frugal four” (Austria, Denmark, the Netherlands and Sweden) secured large rebates on their EU budget contributions, meaning that others will have to pay extra into the budget to compensate.
The centrepiece of the Next Generation EU package is the Recovery and Resilience Facility (RRF). The European Commission plans to borrow €750bn (in 2018 prices) on financial markets through the issuance of long-term maturity bonds (all liabilities to be repaid by 2058). The share of grants has been reduced from €433.2bn in the Commission’s proposal to around €390bn, whereas the loans component has been increased from €250bn to €360bn.
The amount of money that will be disbursed in grants was the main sticking point of the summit negotiations. The leaders of the frugal four had been opposed to the idea of including grants in the recovery package. They gave way during the negotiations, but insisted on a maximum limit of €350bn, and made this concession conditional on “rebates” on their contributions to the EU budget. Finland supported this counter-proposal, but it was deemed unacceptable by France, Germany, Italy and Spain, which wanted to keep the grant component to at least €400bn. Agreement was eventually reached on a €390bn grant envelope, as proposed by Charles Michel, the president of the European Council.
By insisting on a bigger share of grants than loans, France and Germany demonstrated solidarity towards those member states hit hardest by the pandemic, which are also those with the highest public debt levels. The amount to be disbursed as grants had already been reduced from €500bn in the original Franco-German proposal in May: Mr Michel, together with the German chancellor, Angela Merkel, and the French president, Emmanuel Macron, was not prepared to reduce it much further to satisfy the frugal four.
Compromise was reached at the expense of the European Commission’s sectoral priorities. Most of the grant reductions come from the €77.5bn that had been allocated to top up existing EU programmes, green transition initiatives and new research (see table below, with large reductions in red, smaller reductions in orange and increases in green). This is a setback for efforts to reorient the EU budget towards new more innovative sectors. However, these cuts meant that there were no changes to the distributive component of the grants (€312.5bn in fiscal transfers across member states), which will help member states to finance their own reform and investment plans.
The increase in the share of loans means that the overall size of the package could end up being smaller than €750bn, as only countries whose sovereign risk spreads are greater than EU funding costs (such as Italy) are likely to use the RRF loans. Moreover, although member states will be able to borrow at low interest rates and with exceptionally long maturities, countries with high debt levels would have preferred a larger share of grants, as these will not add to debt/GDP ratios.
The summit approved the financing mechanism: the Commission will issue long-maturity, AAA-rated bonds on financial markets. The grants will be repaid from future EU budgets and the loans by member states. The EU has agreed to lift temporarily its “own resources ceiling” (the maximum amount that it can raise from member states per year) to 2% of gross national income (GNI) and the “payments ceiling” (the maximum amount that can be disbursed by the EU budget) to 1.4%. The difference between the two will be used by the EU as a guarantee for its borrowing.
The EU will also increase its “own resources” (tax revenue). The European Council agreed to implement a new levy on non-recyclable plastic waste starting from January 1st 2021. However, the Commission’s proposals for a digital services tax and a carbon border tax were shelved until at least 2023, and given disagreements among member states, may not ever be introduced. Repaying the principal will therefore also involve future seven-year budgets.
The allocation key, which determines how much money each member state receives, was one of the most contentious issues in the negotiations, and the criteria were modified to incorporate the economic impact of the pandemic. The agreed criteria will see the €312.5bn core component of grants allocated as follows:
70% will be committed in 2021‑22 according to the level of population and GDP per capita in 2019, and the average unemployment rate in 2015‑19; and
30% will be committed by the end of 2023. In the allocation criteria for 2023, the unemployment rate will be replaced by the loss of real GDP in 2020 and the cumulative real GDP loss in 2020‑21.
Overall, the country allocation should not change much from the Commission’s initial projections, as countries with weaker initial economic conditions (such as Italy and Spain) will also suffer the most from the pandemic and will take longer to recover.
There will be some political oversight of how the funds are spent, but the summit rejected the idea of member states having a veto on how others use their funds. The €672.5bn RRF will be channelled as financial support for investment and reforms. Member states will prepare recovery and resilience plans for 2021‑23, including milestones and targets, which will be assessed by the Commission in the two months following their submission. The assessment criteria are vague, but suggest that plans will have to be growth-enhancing and should ideally focus on green policies and the digital transition. The European Council will need a qualified majority to approve the plans.
One concession to the Netherlands’ request of a veto is the inclusion of an “emergency brake”. This will allow a member state to review another’s adherence to reform targets at the Council level and to temporarily block disbursements for three months in the case of “serious deviations” from agreed milestones and targets. Nonetheless, the power to validate and authorise disbursement of payments will remain a prerogative of the Commission, meaning that the Council can only delay payments for three months.
Some countries wanted to tie the distribution of funds to respect for rule of law principles. In recent years, the European Commission has accused Hungary and Poland of failing to uphold EU values and undermining the independence of the judiciary. However, strong resistance from Hungary and Poland, which threatened to veto agreement on the overall package, forced EU leaders to retreat. They agreed that the Council (at qualified majority) can block payments to a country on rule-of-law grounds, but only insofar as these threaten the correct management of the funds. It is therefore unlikely that fund disbursements will ever be blocked on these grounds.
The EU parliament must ratify the EU budget, but cannot modify it, and is expected to approve it. Member state parliaments must also ratify the budget by end-2020. There is a risk that the Dutch parliament might object, but the Dutch prime minister, Mark Rutte, can argue that he won significant concessions, particularly regarding the country’s rebate.
Many have argued that the pandemic recovery fund sets a precedent for future fiscal transfers, but we consider this unlikely. The circumstances of the pandemic are exceptional, and the legal and political basis for the fund is therefore temporary. The EU has agreed to common bond issuance and around €300bn in direct fiscal transfers to member states, but we do not see this as leading ineluctably towards a central fiscal capacity or a permanent EU fiscal stabilisation tool. The rancorous negotiations revealed deep divisions in the bloc on these questions, and agreement may have been reached at the cost of further sapping support for the EU project among northern member states.
Adoption of the recovery fund is a crucial achievement in the face of a historic recession. Politically, it sends an important signal of solidarity to those countries hit hardest by the pandemic and provides an antidote to anti-EU sentiment, which has risen recently in the south. It also sends a signal to markets that the European Central Bank (ECB) will not be left to manage the crisis alone, reducing peripheral bond spreads and offsetting fears of financial fragmentation. The overall size of the fund is small in comparison with sums spent by national governments, but helpful for indebted peripheral countries with limited fiscal space. Whether it can prevent a further widening of the economic and political divide between Europe’s sub-regions is doubtful.
We monitor the world to help you prepare for what’s ahead. Find out more about The EIU’s Country Analysis service.
Understand a country’s political, policy and economic outlook with the world’s best forward-looking analysis and data. Our Country Analysis service looks at global dynamics that impact your organisation, helping you to operate effectively and plan for the future.We monitor the world to prepare you for what’s ahead