Recovery fund could permanently change the EU

May 29, 2020 06:00
Photo: Reuters

The German-French proposal for a recovery fund signals that the two largest economies in the EU can compromise and are willing to take a new step towards tighter economic integration. We do not expect the recovery fund to be a one-off measure rather, it has the potential to be the first step towards some fiscal federalism and redistribution in Europe. This would also help to stabilize the euro zone and take some pressure off the ECB to limit sovereign bond spreads.

In this common initiative, France and Germany propose a mechanism to set up a recovery fund in order to help regions and sectors that are especially hard hit by the coronavirus. The EUR 500 billion fund is intended to be financed with bonds issued by the EU Commission in the name of the EU. The debt would be repaid out of the EU budget with a fixed repayment schedule that goes beyond the multi-year financial framework for the years 2021-2027. Disbursements would be made in a front-loaded way as grants rather than loans.

The proposed recovery fund would complement three other pillars of the European economic response to the current Corona-crisis – (1) the additional credit lines of the European Stability Mechanism (ESM) of up to 2% of GDP with light conditionality, (2) the extended resources of the European Investment Bank (EIB) to lend up to EUR 200 billion to companies, and (3) the establishment of a European underemployment scheme (SURE).

So far, the recovery fund is just a bilateral proposal. Southern European countries seem to welcome it while some northern countries are more critical. The EU Commission will make its own proposal on May 27 as requested by EU leaders at their last summit. EU-finance ministers will discuss the issue further at their meeting on June 11 before the leaders are likely to adopt a revised plan at their summit on June 18-19.

The development shows that France and Germany can still work together when a crisis situation demands leadership in the EU. It has probably been a more difficult compromise for the German government than for the French. Germany might have felt some pressure to provide greater solidarity in Europe. After all, Germany has been accused of tilting the playing field of the common market through the huge amount of subsidies received by its companies. Currently, its share of the total amount of subsidies that the EU-Commission has approved is slightly above 50% of all crisis-related subsidies in the EU. The clear rejection of debt mutualisation through Corona-bonds – hence, common bond issuance by nation states – also required the Germans to offer an alternative solution to show solidarity.

Above that, the ruling of the German Constitutional Court (GCC) that the government bond purchases by the ECB are in part illegal called for a political solution to the fiscal problems that some countries face if they react to the extent needed to fight the current recession and to prevent it from causing long-lasting damage to its economies. While we regard the ruling of the GCC as legitimate in pointing out some deficiencies of how democratic control is exercised over the ECB’s monetary policy, the GCC ruling seems to be regarded as problem in most other countries. In any case, it has called for a political solution to the problems that the ECB has so far tried to solve with its government bond purchases.

We don’t expect the recovery fund to be a one-off measure. Instead, it is likely to be followed by others that will lead to greater fiscal federalism and contain bond spreads in Europe.

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Chief Economist, Head Economic Research at Bank J Safra Sarasin

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