29 May 2020

CEPS: The MFF recovery plan breaks with a fundamental taboo

Much is in line with the ‘Next Generation EU’. For the first time the EU is taking a much-needed next step towards monetary union: the ability to raise funds from the financial markets to manage asymmetric negative economic impacts in member states, backed by the Union as a whole.

Perhaps surprisingly, the proposal goes beyond the Macron-Merkel proposals of 19 May. The European Commission proposes raising €750 billion from the financial markets to be repaid between 2028 and 2058, using the high credit rating of the EU to obtain very favourable conditions. It will allocate the revenue directly to the EU budget under the existing headings, even if it uses the special provisions determined by the specifics of the crisis. This makes it easier – at least in principle – for spending to follow EU priorities.

The way the recovery package is distributed is not straightforward. The grant element of the recovery of €500 billion (be this as direct grants or grant elements of financial instruments – guarantees, equity, loans through financial institutions) is distributed across all headings of the budget. The proposal considers this necessary to focus on impacts in areas under the different headings related to the present crisis. In some cases, special sub-headings have been created to indicate that the targets and instruments will be specifically designed for the impacts of the crisis, but some are just added on top of existing headings.

The largest allocation will be to the Cohesion and Values heading. Some €250 billion will be given as loans to member states, in addition to €310 billion in grants under a new ‘Recovery and Resilience Facility’. However, €50 billion more are added to the ‘normal’ cohesion policy. The remaining ‘grant element’ of €240 billion is scattered across the EU budget, including to the Common Agricultural Policy (€15 billion) under the rural development sub – heading to contribute to the Green Deal, biodiversity and Farm to Fork strategies.  The same logic applies to all (except administration) headings, including external action. The ‘orginal’ MFF used in the proposal to which these add-ons are stacked is of €1.100 billion (in 2018 prices), a mid road figure between the Original Commission proposal of €1.134 billion and the Finnish Presidency proposal of €1.087 billion. Somehow, this together with the add-ons can be seen as a way to reverse all moves to cut the original proposal, also a number of add-ons will be controversial. Another view is that it offers a lot of room for negotiation.

Source: European Commission COM (2020) 442 final, p.18.

As some €250 billion of the €750 billion will be distributed in the form of loans to governments, the debt to be repaid by the EU as a collective through the own resources mechanism will be the remaining €500 billion (although the EU would still be liable for any loan defaults on the other €250 billion). It outstanding debt may also be lower, as many guarantees and other financial instruments will not be lost. The €55 billion will be for investment facilities in the InvestEU financial instruments and a solvency fund, which are priced and should be recovered over time (at least partially). Also, the Just Transition Fund, which is meant to assist and accelerate the transformation of regions in transition due to the climate change agenda,  will use guarantees and will not disburse the entire sum in grants.

The proposal has a strong focus on EU priorities, for example the European Green Deal, health and digital. An overriding objective is to invest in areas that contribute to decarbonisation and the energy transition. For example, it proposes that €40 billion be added to the Just Transition Fund.

The proposal is remarkably coherent. And there is no doubt that it is a daring and unprecedented move to enhance the EU’s ability to respond through its budget to crisis situations. It is also a rather important step in the further integration process. Yet in many ways it will face an uphill battle if it is to achieve its objectives and stimulate recovery across the EU.

Focus on the Green Deal, health and digital?

The real risk is how to ensure that conditionalities are in line with the Green Deal priorities. Although the European Commission stressed the need for the recovery money to be spent on health, the Green Deal and digital, it is far from certain that this will be the universal understanding of all member states, despite the lip service they pay. Some may see the ‘free money’ for emergency support aspect more than the conditionality, with the exception of improving the health infrastructure, which is a shared priority. In the past, there was a tendency in Europe to maintain old structures rather than push for change.

Including the recovery funds within the EU budget structure means that the disbursement will require programming, linking it to the European Semester (i.e. macroeconomic conditionality) and the European Commission’s budgetary management and control systems, while being under the budgetary control of the European Parliament. This has its benefits in terms of transparency and accountability. However, possible conflicts between the European Commission and member states or with the European Parliament could slow down the disbursements or reduce the flexibility that will be required.

The EU budget is constructed – and the proposals follow this logic – to ensure the funds are linked to EU objectives, not to suit national political interests. The funds should not just be transferred to member states to allocate as they see fit. But it might be expected that in a crisis like this one, political tensions will arise.

Moreover, programming is complex and sometimes slow; the idea that there can be a rapid and easy deployment to Green Deal areas of investment seems questionable. Assuming that the support is ‘unloaded’ in three years, as appears to be the aim, this would mean an average disbursement of €165 billion in grants per year, in addition not only to the normal EU budget disbursements, but also to the additional €250 billion in loans. Governments will be tempted to focus on maintaining existing structures and will be under pressure to support economic sectors already in trouble before the Covid-19 crisis. It is emergency funding after all, and many countries have limited administrative and absorption capacity and/or difficulty changing their existing programmes and policies. While you drown it is not a good time to learn a new swimming technique. A scenario whereby member states choose expediency over tedious and complex longer-term solutions can be envisaged.

Let us not minimise the programming and capacity aspects at play here. A number of member states have struggled to programme, commit and disburse EU funds. Doubling the EU budget from 2021 to 2024 while requiring programming, full yearly commitments and payment completion by 2026-27 under the existing EU budget rules seems unrealistic. There is a need for highly expedient, emergency-based and flexible provisions. Such provisions would, however, not be easily accepted by those who want more control, more ‘Green Deal’ targeting and more conditionality.

We should not rule out the possibility that the Green Deal is not as popular in practice across all member states as many wish to believe. Many citizens and politicians claim to support Green Deal policies, but this support may shift as soon as it threatens their own jobs and financial situation.

Legal aspects and political will

According to the fundamental principles of the EU budget, the EU cannot borrow for its own expenditure. The proposal will therefore need a temporary extraordinary provision permitting the EU budget to borrow for its own expenditure, i.e. an exception to Article 311 of the EU Treaty. At the same time, this will also require an exception to some principles on EU budget revenues in the Financial Regulation. These decisions will be complicated; a decision in the Council alone on own resources will not be enough, the Own Resources  Decision itself must be agreed only by the Council under unanimity, and impacts on the Financial Regulation, to amend requires the European Parliament as co-legislator. Agreement is in principle possible but might lead to EU horse-trading.

As regards own resources, the rationale for or against them changes little, with or without the proposed borrowed resource. Own resources have their merits and some of them are logically better attributed to the EU to help achieve EU objectives. The argument that they are needed to better service the debt is unlikely to affect the resistance coming from certain member states.

Don’t underestimate the impact on MFF 2021-27 discussions

Under pressure to secure agreement and release the grants, we should not be surprised to see an attempt by some member states to keep overall expenditure as low as possible, as was the case with the then Finnish presidency proposal, for example. The EU budget ‘Next generation EU bonds’ could be an opportunity for the ‘frugal’ member states to argue that there is a trade off with the ‘old budget’. Cohesion support for southern member states could be such an area, but other headings may also become targets. The Commission’s base MFF of €1,100 billion, to which the recovery plan has been added, may not be accepted as such.

It is a landmark proposal, but challenges remain before it becomes operational

What is being proposed may be the start of an EU budget deficits approach. Supposedly a one-off,  it is already the first move to fit another missing piece into the puzzle of a functioning monetary union with a single market. This change is an important step towards making the EU more functional and resilient.

Negotiations for this new package will not be easy. Some member states will find themselves in a difficult position, backpedalling from strong statements under the corona bonds debates when rejecting the principle of mutualisation of debt. Using the EU budget is not the same, but similar enough to cause difficulties explaining a U-turn. Member states could be tempted to apply pressure for reasons of ‘corona crisis’ to cut other important EU budget headings. This is a concern if it means cuts to the most useful non-nationally pre-allocated support so far for innovation, competitiveness and security.

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