Weekly Update - Fiscal Stimulus, EU Style
As is often the case in Brussels, the NGEU plan has had a long gestation. Initial opposition led by the “Frugal Four” – Austria, Sweden, Denmark and the Netherlands – focused on the fund’s mix of grants and loans and on the plan for the EU to issue bonds jointly guaranteed by all members. In the event, members agreed to go ahead with the joint borrowing and fixed the financing split at €390bn in grants and €360bn in loans, instead of the initial 500/250 proposed by the Commission. Then opponents – led this time by Hungary and Poland – held up ratification because of “rule of law” provisions, before a compromise was struck at the December EU summit which also ratified the multi-annual financial framework (the EU’s budget).
And then in late March, a challenge by a group of lawmakers to Germany’s constitutional court halted ratification of the fund, despite a 478:167 vote in favour in the Bundestag. Such objections are not uncommon – last year, a challenge on the constitutionality of the European Central Bank’s pandemic emergency asset purchases delayed formal approval by Germany until a compromise solution was found. We believe that this pattern will be repeated, allowing NGEU ratification to complete successfully on time thereby enabling disbursements to commence by the summer.
It is striking to note the disparity in size between the NGEU and Joe Biden’s $2.29 trillion American Jobs Plan (AJP), some €1.93tn. In part, this reflects the fact that it should be much easier for Biden to obtain approval than it was for the European Commission, which had to break new ground to launch this plan – the US has run a federal budget for centuries whereas the EU still lacks a permanent central fiscal capacity. But in part it also reflects differing starting points and requirements – EU members offer greater welfare provision for citizens, including partial unemployment schemes, while the US had to boost unemployment benefits; moreover, the EU has accumulated a shortfall in investment since the Great Recession whereas the US has underinvested in its physical infrastructure for decades.
At the heart of the NGEU fund will be the €672.5bn Recovery and Resilience Facility which was established in February 2021, leaving member countries until end April to submit their investment and reform plans in six key policy areas (green transition and digital transformation, 37% and 20% of the total respectively, followed by jobs, social cohesion, healthcare and education and skills). The investments are set to be spread over the next six years, representing over 1% of EU GDP per annum on average. This should help close the EU’s output gap, which Deutsche Bank estimates to be around 5% of pre-pandemic potential GDP. All in all, the Commission expects the recovery fund to add some 2% to EU GDP over the next few years.
The financing mechanisms for the NGEU and the AJP will also differ radically. Biden plans to finance the spending via tax increases (see Let’s Talk About Tax) while the EU’s plan is debt-financed (with 30% coming via issuance of green bonds). This means that some of the economic benefits of the AJP may be blunted by a less-favourable tax regime, a burden which the NGEU is likely to avoid.
Bottom line. The jointly-guaranteed borrowing to finance the EU recovery fund will help allay market fears about euro zone break-up, a positive for the single currency. The borrowing will also provide a new benchmark for euro-denominated sovereign bonds, although the negative yields on offer will hold little attraction for investors. The NGEU will provide a solid boost to EU GDP growth in coming years, but this is likely to be eclipsed over the next 18 months by the cyclical recovery we see starting this summer. In sum, we remain Overweight euro zone equities within diversified portfolios.