EU Pandemic Recovery Plan: No Time To Lose

On 19 June, the European Council’s first meeting to discuss the European Commission’s Pandemic Recovery Plan broke up in an impasse. The Recovery Plan forms part of the Commission’s budget or the 2021-27 Multiannual Financial Framework (MFF, Figure 1).

The plan is intended to help countries worst hit by the pandemic and in the words of the Commission, “there is no time to lose”. The European Council seems to be in agreement that the recovery plan is to be financed through EU Commission borrowing in the financial markets – a first for joint and mutual European Union (EU) issuance.

In contrast, how the plan and budget are implemented remains subject to much debate and the outstanding issues, as outlined by European Council President Charles Michel, are substantive:

• the size and duration of the various elements of the recovery plan
• the best way to allocate the assistance and the issue of loans and grants
• questions relating to conditionality and governance
• the size and content of the MFF and its financing, including own resources and rebates

The so-called frugal four – Sweden, Denmark, Austria and the Netherlands – put their views forward last week in a Financial Times opinion piece. They prefer loans and not grants, want the recovery plan’s duration to go to end-2022, are not happy about the plan size and want reassurance on governance.

The leaders’ first in-depth discussion on the plan was on 19 June and a final agreement will come later – the French and Germans are pushing for mid-July. Significantly, Germany takes over the EU Presidency on 1 July and German Chancellor Angela Merkel is siding with French President Emmanuel Macron on the plan’s outline and importance for the Southern European countries.

However, the frugal four could try to change the contours of the deal or even stall it. This would in turn enrage Italy and Spain who want the deal to be done as quickly as possible. Anecdotal reports suggest that after a quick reopening spurt, the Italian economy is returning to recession.

The design and financing of the plan have signaled greater coherence in European policy making and EU states’ agreement on its financing has generated excitement in financial markets. There is also awareness of Italy’s deep unhappiness over the EU’s handling of the COVID-19 pandemic itself.

Investment Implications

Should the July meeting also end in serious disagreement, there could be renewed concerns about what shape the future of the EU could take and even where the monetary union stands.

Moreover, unless a resolution can be found soon and the European Central Bank can show it is acting within EU Treaty guidelines, a German Supreme Court ruling could prove disruptive to quantitative easing operations as soon as August.

Taken together, this would likely put Southern Europe bond spreads under renewed pressure and the euro could lose ground. An implication to consider for MSCI EMU Index equities is that investors in financials and especially banks will be disappointed should the EU fail to implement a coherent recovery plan, with the consequence of further increases in non-performing loans.