EU Recovery fund officially ready for take-off

Last night, the European Commission (EC) sent out a press release stating that all EU Member States have now formally approved the EU’s own resources decision for the EU budget 2021-2027. Crucially, this implies that the EC can now start to issue EU debt securities to fund the EUR 672.5bn (2018 prices) Recovery and Resilience Fund (RRF). Remember, the RRF consists of EUR 312.5bn in grants and EUR 360bn in cheap loans (in total some 5% of EU27 GDP). Hard-hit Member States such as Spain and Italy are eligible for the largest part of the grants in terms of euro’s, while in terms of percent of GDP e.g. Greece stands to benefit even more (figures 1 and 2)[1]. Regarding the loan component, all countries can apply for loans worth 6.8% of their 2019 gross national income. The RRF and hence disbursements will run from 2021 to 2026.

[1] The grant component each country is entitled to is based on several criteria and is not completely set in stone yet: 30% of the maximum amount countries can receive can still be subject to changes, as it will depend on their performance in 2020 and 2021, among other things. The size of that final 30% will be made definitive by June 2022.

The deadline for Member States to present their ‘final’ Recovery and Resilience plans to the European Commission (EC) was end April. At the time of writing, 23 out of 27 Member States, have handed in their plans. The plans of Latvia, Malta, Estonia and the Netherlands - which is involved in tough coalition talks following the March 21 election - are still lacking. For now, missing of the 30 April deadline has no real consequences yet, as plans can still be handed in, but it is unclear whether there is any tough deadline beyond which countries will no longer be able to apply for funds.

Greening and digitalizing the economy

Unsurprisingly, the presented plans so far include large amounts of planned investments for greening and digitalizing the economy. The European Commission required Member States to devote at least 37% of the funds on climate investments and reforms and 20% to foster the digital transition. Buzz words reappearing in multiple plans include electric vehicles, hydrogen research, digitalization of public services and SME operations, enlarging internet networks and improving digital skills of the (working age) population. On top of that, countries tend to focus on their specific challenges such as the North-South and Old-Young divide in Italy. Remember that apart from meeting investment targets, countries will also need to reform inefficiencies currently impeding higher growth. Promised reforms range from tackling bureaucracy and inefficient public administrations, labor markets and justice systems to promoting competition, tax reforms and the sustainability of pension systems.

Less appetite for loan component

Most Member States have only requested the grant component they are entitled to[2]. From the large Member States, only Italy’s plan includes the use of the loan component of the fund, while for example Spain has postponed that decision. It has indicated to come up with a detailed plan to use the loans later on. Meanwhile, Germany and France, intend to fund spending plans beyond the grant component with market financing. Clearly in case of Germany it holds that it can do so at very low costs, while in all cases it holds that market financing is unconditional as opposed to RRF financing. Many plans present timelines for spending over the entire horizon of the RRF i.e. between now and the end of 2026, yet put emphasize on spending the grant component from 2021 until 2023. Spain’s plan reveals the intention to spend the entire amount of grants it is entitled to (EUR 70bn, 6% of GDP) in the coming three years. As we explain below it is highly questionable if it is realistic to assume it will be able to absorb that amount of money in such a short time.

Timeline

The European Commission now has the questionable honor to dig through thousands of pages of plans before the end of June to determine whether they meet the criteria. Thereafter, the Council, has one month to give its consent, or reject to do so – by qualified majority voting. If all goes well, the first funds should start to flow this Summer.

[2] Countries that have also requested a part of the loans they are eligible for are Italy, Portugal, Greece, Poland, and Slovenia.

Once their plans have been adopted by the Council, Member States will be able to request pre-financing of 13% of both the grant and loan component of their plan. Thereafter, disbursements will depend on reaching spending and reform milestones. The timing and content of these milestones will be set by the European Commission (EC) in the current reviewing round of the plans.

Based on experience with the absorption of ‘usual’ European Structural and Investment Funds (ESIF) of the EU budget, it is likely that national capitals will need time to absorb the massive amount of money available through the RRF. The total amount available is about 1.5 times the size of the 2014-2020 ESIF – and even twice that amount for big receivers such as Spain. Moreover, reforming institutions has proved difficult for many governments, both due to technicalities and vested interests. On the bright side, experience with the EU support programs during the Eurozone debt crisis, has showed that in many cases rewards for reforms tend to stimulate governments – at least it has in Spain, Portugal and Ireland. In addition, the major output gap and greening and digitalization (figure 3) challenges ahead suggest there are ample possibilities to put the money to good use, which should support the absorption of funds.

In a first attempt we did earlier this year to calculate the impact of the EU recovery fund – without having the judgement and milestones timeline from the EC - we argued that cumulative GDP impulse for the Eurozone of 0.5% over this and next year would be a fair estimate – with the impulse in, for example, Spain expected overshoot this average, with an estimated impact of 0.8%. Note that this relates to the estimated impact of the actual flow/ use of funds, and excludes the positive impact the creation of the RRF has already had on interest rates.

The impulse will increase in the years beyond our forecasting horizon, as

(i) absorption of the funds by national governments will take time;

(ii) the multiplier of investments – currently set at just below 1 in the initial years - will likely grow over time as investments in skill sets and new technologies improve the productive capacity of the economy (also see the box below);

(iii) it takes time for reforms to bear fruit.

Combined with the reopening of the economy, the improving environment in important trading partners and the already buzzing manufacturing sector – albeit with limitations due to supply chain issues – this means we expect GDP to grow with 4.3% this year and 3.9% next. In our forecast, GDP will be back at its pre-COVID level in the first quarter of 2022. Germany and the Netherlands will be leading the pack, while Italy and Spain will lag their Eurozone peers, given the composition of their economies and the fact that they have larger losses to recover.