Summary
Change occurs at a glacial pace in Brussels, spurred forward by the slow grind of seeking consensus among 27 diverse nation-states. Exhibit A is the past year, where it took a global pandemic to rub out longstanding red lines on the issuance of joint debt among member states. It was back in May 2020 when the recovery fund, dubbed “Next Generation EU,” was first proposed; it went on to be approved in December, and an initial tranche worth €20 billion was raised via a sale of 10-year bonds in mid-June. Those funds are now expected to be disbursed to Portugal sometime in the next month.
Over a year from proposal to disbursement is hardly a frenetic pace. Yet it’s difficult to overstate the importance of this latest evolution in the EU institutional framework, however long it was in the making. The size and symbolism of the recovery plan represent another step toward ‘ever-closer union,’ and the political aftershocks will continue to be felt long after the COVID-19 pandemic has faded from the collective consciousness.
Background
Next Generation EU (NGEU) is a €806 billion recovery fund that is being funded through the joint issuance of EU debt. Though the fund itself is a temporary, one-off mechanism meant to foster a post-COVID economic recovery, its stimulative objectives will be complemented by the Multiannual Financial Framework (MFF), which constitutes around €1 trillion of the EU’s latest, €1.8 trillion seven-year budget. For example, the MFF is projected to contribute approximately €377 billion in spending on ‘cohesion, resilience, and values’ (which broadly includes ‘economic recovery and resilience’), on top of the €721 billion that will come from NGEU via it’s Recovery and Resilience Facility (RRF).
The RRF is expected to distribute up to €312 billion in grants, with the remaining amount coming in the form of loans to member states.
Some €83 billion in NGEU funds will be diverted into other EU programs, such as REACT-EU (coronavirus crisis response), the Just Transition Fund (aiding community-based economic transitions from coal), Rural Development, InvestEU (seed funding for private and public entities), Horizon Europe (EU-based R&D funding), and RESCEU.
S&P Global Ratings has declared that NGEU will “shift European growth into a higher gear,” and the ratings agency sees a GDP boost of anywhere between 1.5-4.1% over the next five years, depending on factors such as disbursement timing, growth multipliers from public spending, and proper utilization of the funds. Member countries Spain, Portugal, Bulgaria, Croatia, and Greece are singled out as the main beneficiaries.
NGEU goals
The first issuance of joint EU debt under the aegis of NGEU took place on June 15. The €20 billion offering was swiftly gobbled up by investors despite the absence of 10 of the largest primary dealers, resulting in rock-bottom yields of just above zero. Herein lies the first obvious objective of the NGEU: to lower borrowing costs of highly indebted euro zone members like Spain and Italy. Over the longer term, increased supply of euro-denominated bonds will expand the market and increase liquidity, making euro bonds a more attractive option for forex portfolios held by central banks around the world. Even before the mid-June initial offering of joint issuance bonds, the euro bond market was booming through the first quarter of 2021, hitting €373 billion worth of auctions by major eurozone governments – 20% higher than last year. Demand has held up in the face of dramatically increased supply, as evidenced by the low rates enjoyed by otherwise questionable borrowers, a trend that appears to be holding up through the most recent rounds of NGEU-related issuance.
Broadly, the recovery fund will focus on three thematic areas, with at least 50% of funding (including from the budget) going toward new priorities. These areas broadly break down into research and innovation, climate transitioning, and direct support of pandemic-related industries. Overall, some 80% of NGEU funding will be used to “support public investment and key structural reforms in member states, concentrated where the crisis impact and resilience needs are the greatest.”
Brussels will be administering the bond issuance and then disbursing funds to national governments on the basis of action plans they submit to the European Commission. These plans outline where the public investments will be directed while laying out clear targets for annual deliverables. The Council, which holds final say over the plans, is not expected to be overly finicky over the details, at least in the early going, due to the long wait that member governments have had to endure in order to gain access to their recovery funds.
The recovery plans of major euro zone economies such as France, Germany, and Italy, have all been submitted as of mid-June, but it’s Portugal that is now lined up for the first approval, with the initial transfers expected in Lisbon in July. Under the plan, the country can expect to receive some €13.9 billion euros in grants and €2.7 billion in loans through 2026.
Portugal’s framework is being held up in Brussels as a benchmark worthy of emulation; indeed, Commission President Ursula von der Leyen has been effusive in her praise of the plan, which she believes “clearly meets the demanding criteria we have jointly established. It is ambitious, it is far-sighted, and most importantly it will help build a better future for Portugal… there is no doubt that it will deeply transform Portugal’s economy.”
All national plans are mandated to spend at least 37% of funds on investments and reforms that support climate change objectives, and 20% must go toward digital transition (Portugal slightly exceeds both targets). The Portugal plan calls for significant investments in urban transport networks, including the MRT systems of Porto and Lisbon, and the purchase of new hydrogen and electric bus fleets. On the digitization front, the plan will invest in digital training for the population and modernize the country’s public services bureaucracy. Finally, some €5 billion has been earmarked for direct support to Portuguese companies, to either shore up balance sheets damaged by the epidemic or invest in ‘innovative’ products and services.
Forecast
The recovery fund is being viewed as an exceptional tool for exceptional times – a rationale that has helped the plan survive intense scrutiny from ‘Frugal Four’ governments in northern Europe, who have together long been averse to the slightest hint of pooled liability in EU debt. But given the massive economic and political stakes involved – a decimated continental economy and Brussels botching its early pandemic response and vaccine rollout – failure is not an option for the recovery fund. Brussels effectively has no choice but to unload the fiscal bazooka over the next five years, unequivocally benefiting the recipient countries, particularly those that would otherwise be unable to secure such vast financial inflows at such favorable rates. But after that comes the hard part: How does the Frugal Four put the toothpaste back into the tube now that fiscal union has been realized, however fleetingly? Some analysts are betting that it won’t be possible to go back. For them, now that the red line has been crossed, joint issuance is destined to become normalized sooner or later. S&P Global has gone so far as to call it a ‘Hamiltonian moment’ for the bloc. Time will tell whether they’re correct, but it seems likely that NGEU could easily become a victim of its own success, at least so far as Frugal Four governments are concerned.
