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France, Germany propose €500 bln Recovery Fund to be fully financed by the EU

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France and Germany proposed on Monday a 500 billion euro ($543 billion) Recovery Fund that would offer grants to European Union regions and sectors hit hardest by the coronavirus pandemic, pushing up the euro and bringing down Italian bond yields.

The two biggest EU countries, whose agreements usually pave the way for broader EU deals, proposed that the European Commission borrow the money on behalf of the whole EU and spend it as an additional top-up to the 2021-2027 EU budget that is already close to 1 trillion euros over that period.

This is a big transformation in policy as German Chancellor Angela Merkel was long opposed to the concept of eurobonds. Under the proposals, the fund will be fully financed by the EU and backed by all 27 Member States. The funds would be distributed by the European Commission in the form of grants within the normal budgetary procedure, and the EU will bear collective responsibility for paying the money back.

Extraordinary circumstances call for extraordinary measures,” Merkel said at a press conference following a video call with Macron following the agreement. Although the size of the fund is smaller than some had expected, the fact that Germany had accepted this shift towards eurobonds was a significant development.

While the proposal was welcomed by the European Commission, it would require the approval of all EU member countries — which promises to be a torturous process — to be realized. Countries such as Austria, the Netherlands and Finland, which share German traditions of parsimony, are likely to oppose the plan, or at least try to.

“That’s a real change in philosophy,” French President Emmanuel Macron said. “I believe this is a very deep transformation and that’s what the European Union and the single market needed to remain coherent. It’s what the euro zone needs to remain united.”

The proposal moves the EU more in the direction of a transfer union and is likely to please countries like Italy or Spain which have long called for more joint action in response to the crisis.

But offering grants rather than loans could be hard to swallow for some of the frugal northern countries of the 27-nation bloc, like the Netherlands, Finland and Austria.

“Our position remains unchanged. We are ready to help most affected countries with loans,” Austrian Chancellor Sebastian Kurz said on Twitter. “We expect the updated (EU budget) to reflect the new priorities rather than raising the ceiling.”

The euro jumped against the dollar to 1.0912 from 1.0851 on the news and bond yields in Italy, one of the hardest hit by the pandemic and which has a huge public debt, fell to a one-month low of 1.67% from 1.79%.

Still, grants from the Recovery Fund will have strings attached – they are to be “based on a clear commitment from Member States to follow sound economic policies and an ambitious reform agenda” the document said.

The money is to be spent particularly on investment in the EU’s transition to a more “green” and digital economy and boost research and innovation.

It is to be paid for through the EU budget that will come after 2027, the Franco-German document said.

France and Germany did not specify whether that would mean higher national contributions based on the size of each economy or some new taxes that would be earmarked for the EU, or a combination of both.

German Chancellor Angela Merkel said the 500 billion euros should be paid back over a long time and that Berlin would shoulder roughly 27% of the funds, as it already does for the regular EU budget.

“We must act in a European way so that we get out of the crisis well and strengthened,” Merkel told reporters.

Reuters / Politico

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