Tom ReesSun, 4 April 2021, 12:34 pm
An unassuming Bauhaus building on the banks of the Rhine is where Europe’s latest crisis is threatening to erupt.
Not for the first time, eight judges inside the drab grey block in the German city of Karlsruhe are railing against the region’s move towards closer ties. This time, the judges on Germany’s Constitutional Court are holding back the ratification of the €750bn Recovery Fund – the cornerstone of the EU’s economic response to Covid.
“Last Friday’s decision bears a high risk of delaying, if not derailing, the crown jewel of the EU’s fiscal reaction to the current crisis,” warns Carsten Brzeski, ING Germany chief economist. “Once again, the German Constitutional Court is at the root cause of potential market tension.”
With the vaccine rollout ratcheting up pressure on Brussels, more delays and division could deal another blow to the European recovery.
“We are concerned the resulting setback to market sentiment might be substantial,” says Reinhard Cluse, UBS economist.
Europe’s Hamiltonian moment
Last year the Recovery Fund was hailed by leaders as a giant step towards closer ties in Europe and a “Hamiltonian moment” by some optimists – a reference to when Alexander Hamilton assumed US states’ debts in 1790, a leap towards creating a united country.
After much wrangling and reluctance from the north, EU members were persuaded to back a fund that would see the European Commission issue significant amounts of debt for the first time to pay for grants and loans. The north would share the economic cost of the larger Covid crisis in the south under the proposals.
But economists warn the landmark fund is losing its lustre. It pales in comparison to the huge, and growing, fiscal action in the US, the money could now be delayed and economists warn the rollout timing means it could provide little boost to the recovery.
The Recovery Fund’s main instrument – the Recovery and Resilience Facility – will provide €360bn in loans and €313bn in grants to EU countries as the flagship of the region’s Covid fiscal response.
The support is aimed at countries with the most strained public finances with southern members seeing their debt piles soar again during the pandemic. More frugal countries in the north, such as Germany and the Netherlands, gritted their teeth as they signed off on the joint debt that will spread risk across the region.
Italy and Spain will take the lion’s share of the money, receiving almost €70bn each in grants under the Recovery and Resilience Facility. As a share of their economies, indebted Greece and Croatia are also big winners.
European solidarity under pressure
Money from the fund was first expected to be delivered in the coming months before the end of the first half of 2021. But that timeline looks in serious doubt as each EU country ratifies the large extension of Brussels’ powers.
All 27 EU countries must approve it, meaning just one member can hold up its delivery. While the two chambers of the German parliament have ratified the deal, the process has been stopped by the Constitutional Court. A motion brought by a eurosceptic group called Citizen’s Will Alliance complained that European treaties prevent the bloc from taking on debt jointly. The judges will rule on a temporary injunction that would stop the law being rubber stamped, opening up a legal battle over the fund.
“The new case is another reminder that steps toward EU integration and burden-sharing are, and will likely remain, subject to intense legal scrutiny in Germany,” says Cluse.
Analysts expect the court to eventually sign off the agreement but it is not guaranteed and it could mean the fund is heavily delayed. Experts warn it could result in a long legal proceeding.
Brzeski says that risks “hurting the eurozone recovery and the belief in European solidarity”.
“At this stage, it is impossible to tell how the injunction and a possible lawsuit will evolve,” he says.
“The more momentous scenario is one where the legal spat hampers ratification until well after the second quarter deadline.”
Brzeski warns this would cause an “adverse reaction in European debt markets” with Greek, Portuguese and Italian bonds likely to be hit.
‘The pace is extraordinarily slow’
Even if the sceptics in Germany fail to block or significantly delay the Recovery Fund, economists are still concerned about the delivery of the grants and loans.
The €750bn was agreed last summer before the second and third waves caused even more economic damage across the region. France has returned to lockdown while Germany has extended tight Covid restrictions as cases rocket, propelled by more the infectious British variant.
Since the deal was first agreed, the fiscal firepower has been dwarfed by efforts in the US. Joe Biden has already pushed through a $1.9 trillion Covid relief bill and has now set his sights on an infrastructure plan that will add trillions of dollars more in longer-term investment.
The EU’s Recovery Fund is worth just 6pc of the bloc’s GDP and spread over six years. By comparison, Biden’s recent relief bill was an instant boost worth around 9pc of GDP.
While individual EU countries have also provided additional economic aid to workers and businesses, many have not been able to deliver packages anywhere near the size of the US or Britain’s even.
“It’s not a fiscal stimulus that’s comparable to what the US is doing, not only on the scale but also on the timetable,” says Andrew Kenningham, chief Europe economist at Capital Economics.
“The pace, even aside from the legal thing, is just extraordinarily slow. It reinforces this sort of impression that the EU when it does things jointly can’t act quickly enough.”
Rather than a crisis-fighting jolt for the economy, he says it has “morphed into long term structural” funding.
Focus on structural investment over recovery
The timing of the Recovery Fund’s rollout is likely to lessen its impact on the recovery. Less than £100bn of the funds will be available this year before the support steps up in size and peaks at almost £200bn in 2023 and 2024.
The last of grants will be delivered six years after Covid first struck, and may not be spent by recipients for even longer.
That makes it less effective at stimulating recoveries and more focused on structural investments, such as digitisation and green infrastructure.
However, it will still allow countries to make important investments without eating into the little fiscal firepower left in southern Europe as debt piles soar well above 100pc of GDP.
Goldman Sachs economist Sven Jari Stehn says it will provide “expanded fiscal space” to members, largely offsetting Italian plans to rein in spending and “contributing to an expansionary stance in Spain”.
He estimates the GDP boost across the big four in the eurozone – France, Germany, Italy and Spain – will be 1pc over the next three years.
Jari Stehn cautions that the biggest risk lies in countries failing to use the funds quickly enough.
“If we focus on Italy and Spain, past experience within the European Multiannual Financial Framework shows that the two countries have been unable to spend more than 50pc of the available funds over a six-year horizon.”
Some economists also warn that some members, such as Italy, have patchy track records on effectively deploying public investment.
“One question is about the timing and the other one is will they use it well,” says Kenningham. “There could be corruption but it also could be used to prop up businesses which are not very efficient.”
Initially hailed as a giant step forward for the European project, the Recovery Fund could be hurt by familiar problems facing the region.