Will Europe’s ambitious recovery fund plan work?

06 August 2021

By Henk Potts, London UK, Market Strategist EMEA

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  • Summary
    • The European Union’s €800bn recovery fund plan known as “Next Generation EU” aims to repair the economic damage caused by the pandemic – as well as supporting green and digital projects across the region
    • Italy and Spain will be the biggest beneficiaries of the fund, but other EU countries are also set to receive significant investments. The reforms are aimed at creating a more equal society
    • The first tranches of the money could be released this month, stimulating economic growth
    • We estimate that the investment projects and reforms will contribute around 1.2% to the bloc’s real growth by 2023.
  • Full article

    The €800bn European recovery fund might be an ambitious attempt to kick-start the eurozone’s economy in the shadow of COVID-19. But will the initiative really lift growth prospects while delivering a greener economy and redefining the bloc’s financial framework?

    In response to the pandemic, a change in the financial framework of the European Union (EU) in recent months aims to coordinate stimulus efforts and put the bloc firmly on the path to fiscal union.

    The European Commission (EC) devised the €800bn European recovery plan known as “Next Generation EU” (NGEU). When coupled with the multiannual financial framework, the plan aims to repair the initial economic and social damage caused by the pandemic, while also creating a greener, more digital, more resilient Europe.

    The road to fiscal union

    After a period of tense negotiations between member states and push back from the so-called frugal four (Netherlands, Austria, Denmark and Sweden) an agreement was reached to embrace the concept of debt mutualisation.

    The ratification of the own resources decision in May1 paved the way for the EC, on behalf of the EU, to begin issuing bonds. Issuance started in June and by the end of the year the Commission plans to issue €80bn in long-term funding. They have targeted distributing 13% of the total funds upfront, most probably by the end of July for at least twelve countries.

    The main component of the NGEU is the funding of the six-year Recovery and Resilience Facility (RRF), with funds distributed in the form of both grants and loans. In an effort to assist the least developed nations, 70% of grants will depend on each member state’s population, the inverse of gross domestic product (GDP) per capita and average unemployment rate over 2015-2019.

    The remaining 30% will be determined by rate of GDP decline since 2020, in order to aid the economies that have been hardest hit by the pandemic. For loans, each member state can request up to 6.8% of its 2019 gross national income.

    Eligibility is linked to promoting European objectives

    In order to receive funds, countries were required to submit their National Recovery and Resilience Plans (NRRP) to the EC. Each plan addresses the challenges identified in the “European Semester” from the EU around coordinating economic and fiscal policy, particularly the country-specific recommendations2.

    Countries were also encouraged to focus on key areas for investment and reform, including clean energy, sustainable transport, digitalisation of public administration, data cloud capabilities and reskilling/upskilling. A minimum of 37% of the funds should focus on climate challenges and 20% to foster the digital transition.

    The fears over the misuse of funds have encouraged officials to demand recipients agree to using the money to meet European-wide objectives, commit to extensive economic reforms and demonstrate progress in targeted areas. States are also required to establish systems to report and record the final beneficiaries of EU funds.

    Where the money will be spent

    Italy will be the largest receiver of EU recovery funds in absolute terms, receiving at total of €205bn (12.4% of 2020 GDP) from the NGEU facility. The Italian government plans to provide tax credits to companies transitioning to high productivity technologies. It also aims to develop a high-speed railway between the north and south and strengthen labour market policies.

    German policymakers will have programmes to “future-proof ” hospitals, the digitalisation of administration and support for the replacement of private vehicle fleets. Germany will also focus on providing funding for more energy-efficient buildings and upgrading of supply chains.

    Authorities in France have pledged to modernise the railway network and develop public transport. They are also investing to improve the energy intensity of public buildings and support research into industrialising electrolysis and fuel cell technologies.

    In Spain, the focus will be on reducing traffic levels and developing sustainable-mobility alternatives. Officials have also pledged to modernise public administration and invest to close the regional digital divide in the country and realise the full potential of 5G for phone networks.

    Benefits and risks of collective debt

    The establishment of debt mutualisation is an important change for Europe. The issuing of joint debt should reduce the risk of fragmentation, lower borrowing costs for a number of states and improve policy coordination.

    Shared debt can also generate a number of challenges. There are concerns that fiscally reckless countries will abuse the credit-worthiness of other states.

    European monitoring mechanisms and enforcement of fiscal rules are known for being weak. As such, compliance is likely to create a continual problem for officials. Some may also argue that the switch to collective debt may further infringe upon national sovereignty.

    Boosting productivity and growth prospects

    The investment projects and reforms should increase EU productivity capacity and sustain above-trend growth in the medium term, assuming the funds are effective and efficiently used. The RRF should provide a sizable fiscal stimulus to demand from the middle of this year, particularly for member states that are net recipients, without directly increasing public debt.

    We estimate that the national plans will contribute around 1.2 percentage points (pp) to the bloc’s real growth by 2023, with the growth impact particularly pronounced in Italy and Spain. The Commission estimates that the economic effect should still be positive with projected growth lifted by 0.5pp at the 10-year horizon.

    These growth estimates exclude the likely positive effect of structural reform on potential growth. However, as always, execution will be the key to deriving the best possible return on investment.


Market Perspectives August 2021

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