Two cheers for the European Recovery Fund

The
recently agreed European Recovery Fund is to be welcomed as a major breakthrough
for the European Union. It is the first time in the EU’s history that member
countries will take joint responsibility for the issuance of a bond for the
benefit of the EU’s weaker individual member countries.

However,
to hail the Recovery Fund as Europe’s Hamiltonian moment, or even as a game
changer, is to grossly underestimate the likely need of the Eurozone’s highly
indebted countries for large-scale official support to keep them afloat.
Especially if the Recovery Fund is the temporary one-off move it is now being
billed as, it will hardly have come anywhere close to solving the sovereign
debt problems of the Eurozone’s highly indebted periphery. 

European Council President Charles Michel is seen on a screen as he attends a virtual meeting with European leaders to discuss the bloc’s budget and recovery fund, in Brussels, Belgium June 19, 2020. Olivier Hoslet/Pool via REUTERS

After
much resistance from a group of four “frugal countries” — Austria, Denmark, the
Netherlands, and Sweden — the European Union finally agreed upon the creation
of a EUR 750 billion Recovery Fund. While a EUR 750 billion headline
number might sound impressive, only a little more than half of this money will
take the form of grants rather than loans. Worse yet, this money is conditional
and is to be distributed over three years between 2021 and 2023. 

This
means that, at best, between 2021 and 2023 only around EUR250 billion will be
distributed from this fund each year for the whole of the European Union. Such
an amount seems paltry in relation to the official support that large Eurozone
member countries like Italy and Spain might need over this period when the
global liquidity cycle turns. This would especially seem to be the case given
those countries’ very shaky public finances and their very weak banking
systems. 

It
might be recalled that the IMF is now projecting that the coronavirus pandemic
will likely cause both the Italian and the Spanish economies to contract by 13
percent in 2020. That in turn will cause the budget deficits of these countries
to blow out to at least 10 percent of GDP in 2020 and will lead to a jump in
their public debt to GDP ratios by end-2020 to around 160 percent for Italy and
120 percent for Spain. The deep economic recession is also bound to create
major problems for both of these countries’ banking systems.

Italy
alone currently has a gross government borrowing need of EUR 650 billion a year
and a banking system with a EUR 4 trillion balance sheet. This would imply that
over the next three years, Italy’s need for official support could easily
amount to some EUR 2 trillion. Yet over the same period the Recovery Fund is
envisaging distributing to Italy only some EUR 210 billion, of which EUR 80
billion would be in the form of grants and EUR 130 billion would be in the form
of low interest rate loans. In total, these funds would cover barely 10 percent
of Italy’s prospective need for official support.

Welcome as the European Recovery Fund might be, it would not seem to go nearly far enough to support the Eurozone’s weaker member countries. Instead it seems to leave all of the heavy lifting to hold the Eurozone together to the European Central Bank through its quantitative easing policy.

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