After loading up an economic bazooka to counter the impact of the coronavirus, some EU countries are hesitating over using a significant part of the ammunition.
EU leaders in July agreed on a €750 billion debt-fueled recovery fund, split into €390 billion in grants and €360 billion of low-interest loans. The deal was saluted as an extraordinary feat, moving the bloc a step closer to federalism. Yet many of those that fought hard for an ambitious package are now snubbing the loans.
The reticence on borrowing stems from a desire to avoid adding to already-high government debt levels, as well as memories of the rescue programs following the 2008 financial crisis, with their harsh conditions and enforcement. On top of this, any EU country benefiting from borrowing costs equal to or lower than those of the Commission has little incentive to subscribe to its loans.
Of nine mostly southern EU countries that in March signed a letter calling for a common debt instrument of “sufficient size and long maturity,” three have declared they don’t plan to access the loans for now. Four others are hesitating, and those that do want to take the loans, like Italy, hope the debt won’t sink their balance sheets. Northern, wealthier countries with lower debt may forgo the loans altogether.
“The bazooka numbers that were being discussed back in July no longer apply as the recovery fund is effectively halved,” said Mujtaba Rahman, Europe director at political risk consultancy firm Eurasia Group.
As Europe battles with the second wave of the pandemic, governments may indeed need to throw more money at their economies, and countries have until 2023 to request access to loans. But for now there’s not much interest.
The European Commission thinks that EU countries will change their minds. “I’m pretty sure that on the loans side there might be a change of opinions among member states,” Johannes Hahn, the budget commissioner, told a press conference on Wednesday. “The conditions the EU can provide are for many member states much more favorable than if they would borrow on their own.”
Troika memories
Portuguese Prime Minister António Costa in September said the country’s high debt means “the option we have is to make full use of grants and not use the part related to loans until the country’s financial situation allows it.” Portugal’s ratio of debt to economic output rose 6 percentage points to 126 percent in the second quarter, according to Eurostat.
In its blueprint plan for recovery, shared with Brussels earlier this month, the government reiterated this point, saying Portugal will “minimize the use of loans that may give rise to an increase in public debt.” It added that €4.3 billion in proposed loan-financed expenditures “deserve a careful assessment of their eligibility, and under what conditions.”
“Conditions” is the key word here, as the macroeconomic reforms and budget cuts tied to the loans handed to Greece, Cyprus, Ireland, Spain and Portugal following the 2008 financial crisis are still fresh in these countries’ memory, making many squeamish at the thought of new high-stakes bailouts.
Unsurprisingly, Greece — which was forced to slash public spending and pensions under the terms of its international bailout — is not eager to subscribe to more debt. Greece’s debt is the highest in the eurozone, as a ratio of its gross domestic product, at 187 percent. “Nothing is concluded yet,” said one Greek official. “The interest rate of Greece is very low” at the moment, the official said, adding that “it doesn’t seem” that Greece will need to use the loans “but we will see.”
Federico Steinberg, economist and senior analyst at the Elcano Royal Institute in Madrid, said there is a “stigma” around the use of EU loans associated with the “men in black” — the so-called Troika supervisors from the European Commission, the European Central Bank and the International Monetary Fund that regularly visited the capitals of bailed-out countries during the financial crisis.
“The rhetoric of the men in black was very constant and very hard in 2012-14,” he said.
Spain will “prioritize” the grant component in its recovery plan — amounting to €72 billion between 2021 and 2023 — while only accessing the loans later “if needed,” said an official in the prime minister’s office. “We will use grants first, but we are not giving up on any tool,” he said. “If we needed extra cash by 2023, we would use the loans.”
Relative interest rates
The interest rate at which the European Commission, enjoying a triple-A rating from most rating agencies, is going to borrow money on capital markets and pass it on to EU countries is another factor influencing loan take-up.
Last week, the Commission’s first issuance of €17 billion of bonds under the SURE unemployment program — separate from the recovery fund, but operated by the same back-to-back loan structure — drew strong demand in the market. The 10-year bonds were issued at a yield of minus 0.24 percent, which will be passed on as negative interest rate to EU countries. This represents a “huge advantage” for countries with higher borrowing costs, said a senior EU official.
But for now there’s little enthusiasm.
France, which also borrows at negative rates, is not interested. “For the moment we are not asking for loans, as the Commission’s borrowing rates are higher or equivalent to those of France on the markets,” said a French Treasury spokesperson. An Irish official said Dublin hasn’t decided yet, and that “any decision will factor in the price of funds at the time the decision is taken.”
Slovenia and Belgium are of the same mind. Ljubljana intends to use the loans “only in case that the relevant borrowing terms and access requirements prove to be more favorable than for other financial arrangements available on the market,” a government spokesman wrote in a statement. A Belgian diplomat said that “the choice of using loans or not will depend on the market situation.”
Debt straitjacket
Since loans add to countries’ outstanding debt balance, reluctance goes hand in hand with the ongoing debate on when the EU will reinstate its budgetary rules, including a limit for indebtedness of 60 percent of GDP. After stepped-up spending to combat the impact of the coronavirus, the average in the euro area now tops 95 percent, led by Greece, Italy and Portugal.
While the Commission has said that the rules — lifted for the first time ever in March to allow countries to prop up their locked-down economies — won’t make a comeback before 2022, there’s growing anxiety that this might be too early for heavily indebted EU countries.
Spanish Prime Minister Pedro Sánchez said debt reduction will only happen “once we achieve a rigorous enough growth, and recover pre-pandemic GDP levels.” French President Emmanuel Macron has said he doesn’t expect EU debt rules to return as they were.
Italy — among the worst-hit countries in the first wave of the pandemic, and the largest beneficiary of the bloc’s recovery fund — is planning to access the full amount of the loans, largely due to higher national borrowing costs, according to a Treasury spokesperson. But the government worries about its debt levels. Italy’s debt will grow by 23 percentage points of GDP this year alone, according to the government, and Rome is planning a return to 2019 debt levels only by the end of the decade.
Given the lack of clarity on when or how EU budget rules will be reinstated, governments are erring on the side of caution. That was reflected in the draft budgets sent to Brussels, which envisage a tightening of the public purse for 2021 compared with this year, when spending has ballooned due to the coronavirus.
The reluctance of multiple countries to apply for the loan portion of the package, combined with a tightening of national budgets, risks diluting the impact of the recovery fund, according to some analysts. “One big downside from the lack of loan take-up is the signal it is sending to markets about the magnitude of the expected stimulus,” said Rahman.
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