The Franco-German initiative: A promising start
Head of Macro Analysis
Summary: Yesterday, French president Emmanuel Macron and German Chancellor Angela Merkel proposed joint debt issuance by the EU to fund the European recovery package. This bold initiative, characterized as an Hamilton moment by many commentators, has rapidly been endorsed by the EC, the ECB and Spain, but there is still a long road ahead to convince the Frugals in the North.
Ahead of the EU meeting scheduled on May 27, yesterday evening, the Franco-German couple released its post-covid plan (see here) which includes among the main proposals EU budget spending worth €500bn financed by what is effectively federal issuance integrated in the MFF (for the period 2021-27), a new EU health strategy based on R&D and common stocks, the acceleration of the EU green deal via a deepening of the Emission Trading System (e.g. minimum price for CO2 and further investment incentives for the private sector in decarbonization) and a strong call in favor of economy sovereignty which suggests, especially, the implementation of a new industrial strategy and the deepening of the single market.
The main characteristics of the Franco-German proposal for the EU recovery fund:
- The €500bn fund would not be loan-based but rather direct spending so the funds are not counted as member state debt – which was one of the preconditions stipulated by Italy over the past weeks.
- The funds would be borrowed by the EC, presumably on Art. 122 TFEU basis, and would be integrated into the MFF for the period 2021-27. Article 122 TFEU states that:
“Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the Member State concerned. The President of the Council shall inform the European Parliament of the decision taken”.
- This new EU debt would be implicitly backed by future member state contributions which are calculated based on gross national income. Guarantees in the EU budget would be set up to make sure that all member states, including recipients of funds, would commit to debt service repayment.
- At this stage, the details about allocation of spending between countries, regions and sectors are still blurry, but the main idea would be that the most affected would be those who benefit most from the support mechanism.
- This new debt, as all EU-issued bonds, can be purchased by the ECB under the PSPP and PEPP.
If endorsed by other countries, this initiative would be a welcome addition to the existing package consisting in:
- The activation of the ESM credit line with soft conditionality attached (no enhanced surveillance and no macro conditionality). The maximum average maturity of ESM loans stands at 10 years and the spread over the funding rate charged by the ESM to cover ESM costs is at 0.1%.
- The extra financing for businesses through EIB loans, up to €200bn.
- The Commission’s unemployment reinsurance scheme (SURE), up to €100bn.
Comment: This is not the first time that the EU is planning to issue joint debt. In the past, the EU has issued debt for macro-financial assistance or balance of payment support, but for much smaller amounts. The two main differences this time are the large amounts at stake (€500bn) and the political will driving this initiative that can potentially open the door to further fiscal integration and more permanent solidarity transfers between the North and the South in the very long run. One can even imagine that political leaders will resort to EU joint debt in the near future to address other particular problems, such as climate change or the refugee crisis. It is still unclear whether the German court ruling played a role in Chancellor Merkel’s decision to move forward, but the Franco-German consensus is undeniably a promising step.
However, there is still a long road ahead before the €500bn expenditure fund becomes reality. The main question is whether France and Germany are ready to go all in and convince other member states, especially the Frugals, it is the right thing to do. It is illusory to believe an agreement can be reached by May 27, when the next EU meeting is due to take place, or even in early June. The unanimity rule, which should have been replaced by majority rule a long time ago, implies that a compromise can only be reached after long and intense negotiations, and we cannot exclude that a blocking minority of one or two countries jeopardizes the whole process at the last minute. An intense political bargaining will take place between the Franco-German couple and other member states in the coming weeks. We identify two main risks associated with this process. First, the essence of the project might be altered (e.g. new spending are not necessarily channeled to countries that need it most). Secondly, Germany and France could be inclined to accept an infamous compromise with some Eastern countries in exchange for their support. One can imagine that Hungary or Poland could accept to endorse the Franco German initiative only on the condition that the EU is less intrusive with regard to respect of democratic rules in these two countries.
As we have said, the Franco German initiative is an excellent news, but it is too early to cheer ourselves up.