BRUSSELS — Should the European Union borrow money as if it were a single country? It’s a question that bitterly divides EU capitals, and now the European Commission has taken a clear side.
Without much fanfare, Commission President Ursula von der Leyen proposed expanding Brussels’ power to borrow hundreds of billions from international investors as part of the seven-year EU budget proposal that was announced on July 16.
It wouldn’t be a carte blanche to borrow at will, however. Under the plan, EU-level debt would be limited to financing Ukraine’s war effort, responding to unforeseen crises, and making specific payments to EU governments.
But the EU executive will nevertheless have to overcome stiff resistance from wealthy northern countries such as Germany and Netherlands — nicknamed “the frugals” for their aversion to excessive borrowing — who see joint debt as an existential threat to the European project.
“We cannot have borrowing-funded programs,” Germany’s Europe minister, Gunther Krichbaum, said in response to the budget proposal earlier in July — even though this year Germany has substantially changed its position on debt-fueled domestic spending.
The frugals’ fierce opposition meant common debt was off the table until 2020, when capitals reluctantly granted Brussels the power to issue EU bonds and give grants to countries to deal with the economic impact of the Covid-19 pandemic — on the strict proviso that it was a one-off thing.
The Commission sees its latest proposal as a clever workaround to make its budget less dependent on the contributions of recalcitrant member countries, which are the EU’s biggest source of income. For euro enthusiasts, it’s a key building block to create a supranational body that possesses its own fiscal firepower.
“Everywhere we go, we hear the investors worldwide asking for more, because they want to buy Europe,” Stéphanie Riso, the Commission’s top budget official, said last year.
Joint debt issuance gives the Commission leverage to attach conditions to the payments it doles out to national governments, effectively allowing it to “steer national spending in areas that are beneficial from an EU perspective,” said Nils Redeker from the Jacques Delors Centre think tank.
The EU’s debt dilemma
Common borrowing is appealing to countries with high debt such as Italy and France, as EU loans offer lower interest rates than if they borrowed in their own names.
But frugal countries are opposed, as they would be collectively liable for any country defaulting on the EU’s debt.
“There’s even more skepticism [in Germany] toward the idea to use structured EU debt to finance national expenditures,” Redeker said. “That’s something that is very hard to digest and comprehend for Germany.”
“Loans only shift the financial burden to the future so it doesn’t solve the problem, it delays it,” echoed an EU diplomat who was granted anonymity to talk about sensitive discussions.
Under the budget proposal, countries can request EU loans that they’ll have to repay if the cost of their spending plans — which mainly include farmers’ subsidies and payouts to poorer regions — exceeds the amounts that were initially set aside.
While this idea is anathema to the frugal countries, supporters counter that the loans carry no financial risk as it “has never happened before in the history of the EU that a member state has defaulted on any EU loan,” a senior Commission official said.
Separately, the Commission can also hand out up to €395 billion in cheap loans to countries facing an unexpected and unspecified crisis. In a concession to critics of joint debt, however, the approval of national capitals and the European Parliament is required to trigger this mechanism.
The only justification for grants ― effectively free money ― is to finance Ukraine, an aim that is uncontroversial in most EU capitals. A €100 billion cashpot for the war-battered country will include a mix of loans and grants that hasn’t yet been agreed.
Market reaction
Currently, markets treat EU joint debt more like the debt issued by supra-national organizations like the World Bank or the European Investment Bank.
But the Commission would like to see it treated like government bonds. That would allow EU bonds to be included in sovereign debt indexes that receive billions of euros of investment, lowering borrowing costs.
But EU debt is already “very much appreciated by investors,” said Alvise Lennkh-Yunus, managing director at Scope Ratings, which gives it an AAA rating. “I think that simply speaks to the strength of the governance framework of the European Union, the backing of the EU budget, the backing by the member states, and the whole financial architecture around issuing these bonds.”
He said big investors like pension funds and foreign central banks are scooping up EU bonds to diversify away from dollar-denominated assets like U.S. Treasury bonds, which have started to look more wobbly, victim to the uncertainty fanned by the Trump administration.
“My feeling is that they [U.S. policymakers] are concerned that if we go on the global market and borrow more we might become a crucial competitor for the dollar,” socialist MEP Victor Negrescu told POLITICO after visiting the U.S. earlier in July.
Still, there’s some way to go before joint borrowing can really rival sovereign bonds. For this, the EU needs to periodically return to the markets — like countries do to finance their budgets — to create a truly large and liquid pool of bonds that investors can rely on.
Olivier Blanchard, a prominent economist who has called for a large-scale conversion of national debt into EU joint debt, argues creating a big, consistent market in EU bonds is essential if they are to have global impact and strengthen demand for euros. An irregular spatter of borrowing won’t do it.
“If you’re a big fund and you’re thinking about your portfolio, you’re not inclined to be excited at the idea of holding something which is going to disappear in time,” Blanchard said.
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