Divided Europe: The battle between loans and grants

Today’s agenda :

• The European Commission will present its revised long-term EU budget proposal and its recovery plan. It is unclear whether the latter will be directly inspired by the Franco-German initiative unveiled last week (see here) that was initially endorsed by the Commission.
• A final agreement is expected to be reached at the EU Council meeting on 18-20 June.
• The recovery plan might include billions of euros to promote circular economy and the green transition. According to working papers, the funds allocated to hydrogen energy could double to €1.3bn and €10bn could also be invested in the development of this technology over the next ten years. For the automotive industry, the EC is expected to propose an EU-wide clean vehicle purchase scheme, for about €20bn over the next two years, that could top national initiatives (like the one that was decided yesterday in France).

Over the weekend, the Frugal Four have published a non-paper that was intellectually lazy and basically proposed a one-off, two year emergency loans. The only real point of agreement between the Franco-German initiative and the Frugal Four’s non-paper was that the recovery plan is linked to the MFF. However, it seems that the position of countries most resistant to further European solidarity has changed over the past hours. Both Denmark and Austria appear to be willing to compromise on the future EU budget and recovery plan. Danish foreign minister indicated that his country will participate “constructively” in negotiations and work for a “sensible” and “fair” compromise. For his part, Austrian finance minister opened further the door to a mix between grants and loans, stating that “some EU virus aid can be handouts”. Adding to the ongoing optimism, in a surprising move, the conservative German newspaper FAZ endorsed de facto small fiscal transfers on Monday: “Now it is not the time to make countries pay for past failures. It is the time to help each other. The futures of the EU relies on everyone pulling in the same direction” (see here the article, in German). It is a very strong signal that Chancellor Merkel’s persuasion job appears to be working quite well among German conservative elite.

However, it is still too early to declare victory, it is likely that the diplomatic battle between France and Germany on one side, and the Frugal Four on the other side is not yet over. The proposal that the EC will unveil in a few hours will open a new phase of intense political bargaining between member states that could lead to a final agreement at the earliest at the next EU Council in June. There is not only resistance to the Franco-German proposal in Northern Europe, but also in Eastern Europe where countries have been so far among the main beneficiaries of EU funds and are unhappy that money will be redirected South rather than East.

Even if there are encouraging signs that support for more European solidarity and fiscal union is gaining traction, it is too early to predict the outcome of the negotiations between member states. What is certain is that Europe is once again wasting precious time needed to fight the economic crisis. While Singapore presented its fourth recovery plan since the outbreak yesterday, Europe has not even agreed on the final terms of its first recovery package.

Helped by a decade of research into systemic risks and financial/macro spillovers, the ECB has successfully managed to avoid a liquidity and financial crisis. We expect the central bank will remain in preventive mode and announce further easing at the June meeting consisting in the expansion of the PEPP by €500bn in order to absorb coronavirus debt, and the extension of the programme at least until September 2021. If needed, the ECB can even do more, by increasing the share of supranational debt in the PSPP, cutting further TLTRO rate or even purchasing bank loans as the Fed is doing with the Main Street Facility. In our view, the Eurozone is six to twelve months away from the United States in terms of accommodative measures, but it is bright clear that the current monetary policy cycle will de facto lead to a renationalization of the sovereign bond market on both sides of the Atlantic. But to the fully efficient, the ECB needs fiscal backup, not tomorrow, not the day after tomorrow, but today, right now. Europe has already wasted too much time in political bickering.