HomeBreaking down Europe’s €500 Billion Recovery Fund

Breaking down Europe’s €500 Billion Recovery Fund

Two days ago, a French-German proposal to raise €500 billion for a Recovery Fund was cheered by markets around the world. The idea was original and surprising at the same time. The funds will be integrated into the multi-year budget and distributed not as grants, but as budget transfers. Moreover, they will be distributed not according to GDP, but to how affected a country is by the coronavirus crisis.

The European Commission Borrows Long Term

The plan is for the European Commission to borrow from international financial markets in the long term (25 years). It will then issue bonds (rated AAA) that should have no problem finding buyers.

Even if that were to pose an issue in the future, the European Central Bank (ECB) could then look to purchase EU-issued bonds. These bonds are exactly that, and therefore eligible for the PESPP, and public sector purchase programme (PSPP) ran by the ECB.

How is the Debt Paid Back?

The new debt will be added to the annual payment budget contributions which each country makes. The math tells us that for a twenty-year bond, total debt service with amortization included will be exceptionally low – below 0.5%, varying from country to country.

Of course, member states must commit to sound economic policies and a tight reform agenda. However, that is something to worry about later down the road when hopefully the world finds a way to deal with this pandemic.

The main message sent by the two countries was one of solidarity and trust – solidarity with the countries affected the most and trust that Europe is not easily divided. For financial markets, trust is all that matters.

During the 2012 sovereign debt crisis, Mario Draghi, then the ECB President, used the famous “whatever it takes” line during a speech in London. It was for the first time a President of the ECB implied that the central bank is here to close the spreads – and the market took his word for it. Thus, he established trust in the system and spreads came down, easing the burden of the indebted European countries.

A similar reaction happened after this week’s announcement. After both the ECB and the European Commission endorsed the plan, it seems the road for the first European bonds is paved.

When Germany and France lead, the others in Europe follow. It was the same during the time of Helmut Kohl and Francois Mitterrand and remains valid today in the time of Angela Merkel and Emmanuel Macron.

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