At a special in Brussels on March 6, the bloc’s 26 member states decided to mobilize about €800 billion ($867 billion) for what the leaders described as , was tasked with working out the details soon on how members could be helped to finance their share in the effort.
At the moment, it appears that are able to finance some €650 billion of the €800 billion package through their own sovereign debt issuing, rather than through joint EU borrowing.
The remaining €150 billion is expected to be loan assistance secured by the EU budget which would bring the bloc a step closer to the concept of shared debt.
Unlimited debt
In Germany, chancellor-in-waiting has already discarded his no-new-debt mantra from the election campaign and is now advocating unrestricted borrowing to finance national defense efforts, as he recently said.
To encourage other EU countries to follow a similar approach, von der Leyen wants to activate what she called an “escape clause.”
“This will allow member states to significantly increase their defense spending,” she said at the in February.
Jürgen Matthes, who heads the research unit International Economics and Economic Outlook at the Cologne, Germany-based Institute for Economic Research (IW), thinks von der Leyen’s escape clause could help EU member states make their defense expenditures compatible with the bloc’s so-called Stability and Growth Pact.
In force since 1998, the pact sets a public-debt limit of 60% of GDP and a budget deficit limit of 3% for the 20 countries that currently use the . However, originally intended to prevent excessive national borrowing, many eurozone nations have repeatedly broken the principle.
If these countries need to take on additional debt to finance their military needs, Brussels will likely turn a blind eye rather than imposing penalties, as it has done in the past.
Interest rate spreads as a warning signal
Within the EU, softer implementation may give governments more fiscal room to maneuver, but whether financial markets will be convinced remains to be seen. Financial market investors primarily focus on a country’s creditworthiness, which is reflected in ratings assigned by specialized agencies. A poor rating makes borrowing more expensive.
Among eurozone countries, Germany pays the lowest interest rates on its debt. The difference between German interest rates and those of other countries is called the “spread.” Italy, for example, must pay a so-called risk premium of 1.2 percentage points compared to Germany, meaning it has to pay more for its debt.
At the start of the EU sovereign debt crisis in 2010, the gap was even smaller but soon surged to nearly five percentage points. For Portugal and Greece, the premium was even higher.
The higher the interest rate, the less financial flexibility a country has for other priorities, such as investments, education, or pensions. These imbalances pushed the eurozone to the brink of collapse during the debt crisis.
The impact of new defense-related debt on spreads is “not yet clear,” Matthes told DW. He wouldn’t rule out the risk of individual eurozone countries taking on more debt than they can shoulder under rearmament efforts.
Has the time come for Eurobonds?
Large expenditures come with large risks — so, is this the moment for joint borrowing through so-called Eurobonds?
The concept is simple: If European countries take on debt together, borrowing conditions would be more favorable for most nations than if they issued debt individually. They would benefit from the strong credit ratings of wealthier member states. Rich countries, like Germany, however, would then be liable for the total debt raised through joint EU debt.
The issue has divided the EU for many years, with the fault line running more or less along a north-south axis. Northern countries — including Germany, Austria, the Netherlands, and Finland — accuse southern countries such as France, Italy, Spain, Portugal, and Greece of fiscal irresponsibility and have refused to back their debt.
EU law also prohibits one country from assuming the debt of another. Article 125 of the Treaty on the Functioning of the European Union explicitly states this restriction.
To use Eurobonds for defense financing, an amendment to EU treaties would be necessary. Such a change would not only be time-consuming but also require unanimous approval, raising doubts about its feasibility.
However, the EU has already experimented with collective borrowing, albeit with limited liability.
For example, the €750 billion recovery fund established during the pandemic in 2021 marked the first time the EU collectively took on debt. In this case, liability was limited to each country’s share of the EU budget — meaning Germany was responsible for about a quarter of the total amount.
Similarly, the so-called and its predecessor, the European Financial Stability Facility (EFSF) — both bailout funds to help struggling eurozone countries during the 2010 sovereign debt crisis — were forms of joint debt.
Necessary, unlikely, or practical?
“Whether joint borrowing will be necessary remains to be seen,” said Matthes from the IW.
Clemens Fuest, president of the Munich-based ifo Institute, considers it “very unlikely” that defense spending will be financed through shared debt.
“This instrument is unsuitable because defense expenditures are national expenses, and the EU would first need to develop a defense policy concept. But right now, urgency is the priority,” Fuest told DW via email.
But Jens Boysen-Hogrefe from the Kiel Institute for the World Economy (IfW), sees joint debt as “practical” when financing shared military initiatives. In an interview with DW, he questioned, however, whether “all EU countries would fulfill their commitments to common defense in the coming years.”
Boysen-Hogrefe thinks joint borrowing for Europe’s defense should also involve non-EU countries like Britain and Norway to ensure that decisions are not subject to the EU principle of unanimity. That would prevent countries like Hungary from using a veto to block progress. Additionally, the European Investment Bank (EIB), which is jointly owned by EU member states, could play “a key role,” he said.
For now, the details of how Europe will fund its rearmament remain unclear — just like whether Friedrich Merz will reconsider his firm opposition to joint debt.
In September last year, Merz said he would “do everything in my power” to prevent the EU from “entering such a debt spiral.” He did not respond to DW’s request for comment on whether his position has changed.
This article was originally written in German.
The post Eurobonds: EU plans debt revolution to finance defense appeared first on Deutsche Welle.
