How Europe plans to pay back its massive stimulus debt

The European Union (EU) faces a daunting challenge of repaying its unprecedented stimulus debt that was incurred to combat the economic fallout of the Covid-19 pandemic. The bloc’s fiscal rules, which limit the budget deficits and debt levels of member states, have been suspended since 2020 and are expected to be reinstated in 2023. However, the EU will also have to find new sources of revenue to finance its ambitious recovery plan, known as NextGenerationEU, which aims to transform the continent into a greener, more digital and more resilient economy.

How Europe plans to pay back its massive stimulus debt
How Europe plans to pay back its massive stimulus debt

The EU’s stimulus debt is composed of two main elements: the national borrowing of member states and the joint borrowing of the bloc under the NextGenerationEU program. The national borrowing reflects the fiscal response of individual countries to the pandemic, which varied widely across the EU. According to the European Commission, the aggregate general government deficit of the EU reached 7.2% of gross domestic product (GDP) in 2020, up from 0.6% in 2019. The aggregate debt-to-GDP ratio rose from 77.5% in 2019 to 90.7% in 2020. Some countries, such as Greece, Italy, Portugal and Spain, saw their debt ratios exceed 100% of GDP.

The joint borrowing of the EU under the NextGenerationEU program is a novel and unprecedented feature of the bloc’s fiscal policy. The program, which was agreed by the 27 EU member states in July 2020, consists of a temporary recovery instrument of €750 billion ($857 billion) and a long-term budget of €1.074 trillion ($1.225 trillion) for the period 2021-2027. The recovery instrument, also known as the Recovery and Resilience Facility (RRF), is financed by issuing common bonds on behalf of the EU, which will be repaid over 30 years starting from 2028. The RRF will provide grants and loans to member states to support their investment and reform plans, with a focus on the green and digital transitions.

The joint borrowing of the EU under the NextGenerationEU program is expected to increase the bloc’s debt-to-GDP ratio by about 6 percentage points by 2026, according to the European Commission. However, this debt will not be added to the national debt of member states, but will be serviced by the EU’s own resources, which are mainly composed of customs duties, value-added tax (VAT) contributions and a share of corporate tax revenues.

The challenges of debt sustainability and repayment

The EU’s stimulus debt poses significant challenges for the bloc’s fiscal sustainability and repayment capacity. The first challenge is to ensure that the national debt of member states remains under control and does not jeopardize the stability of the euro area. The EU’s fiscal rules, which are enshrined in the Stability and Growth Pact (SGP), require member states to keep their budget deficits below 3% of GDP and their debt levels below 60% of GDP, or at least on a declining path towards that threshold. However, these rules have been widely breached and criticized for being too rigid and procyclical, especially during the sovereign debt crisis of 2010-2012. The EU has launched a public consultation on how to reform the SGP, which is expected to conclude by the end of 2022.

The second challenge is to find new and sufficient sources of revenue to repay the joint debt of the EU under the NextGenerationEU program. The EU’s own resources, which currently amount to about 1% of the bloc’s GDP, are not enough to cover the annual interest and principal payments, which are estimated to reach €15 billion ($17 billion) and €50 billion ($57 billion) respectively by 2058. The EU has agreed to introduce new own resources, such as a carbon border adjustment mechanism, a digital levy and a financial transaction tax, which are expected to generate additional revenues of €15 billion ($17 billion) per year by 2027. However, these new sources are still subject to political and technical negotiations and may face legal and practical obstacles.

The third challenge is to ensure that the stimulus debt is used effectively and efficiently to boost the EU’s economic growth and resilience. The EU has set several conditions and criteria for the allocation and disbursement of the funds under the NextGenerationEU program, such as the respect of the rule of law, the alignment with the EU’s strategic priorities and the achievement of specific milestones and targets. The EU has also established a governance framework to monitor and evaluate the implementation and impact of the national recovery and resilience plans, which are submitted by the member states and approved by the European Commission and the Council. However, the EU will also have to deal with the risks of corruption, fraud and misuse of the funds, as well as the potential trade-offs and conflicts between the different objectives and interests of the member states and the bloc as a whole.

The opportunities of the stimulus debt

Despite the challenges, the EU’s stimulus debt also offers some opportunities for the bloc’s economic and political future. The first opportunity is to enhance the EU’s fiscal capacity and integration, which have been long-standing and contentious issues in the history of the European project. The joint borrowing of the EU under the NextGenerationEU program represents a historic step towards a form of debt mutualization and fiscal solidarity among the member states, which could pave the way for a more permanent and comprehensive fiscal union in the future. The EU’s fiscal capacity could also be strengthened by increasing and diversifying its own resources, which could reduce its dependence on national contributions and increase its autonomy and legitimacy.

The second opportunity is to foster the EU’s economic convergence and cohesion, which have been challenged by the divergent and asymmetric effects of the pandemic and the previous crises. The NextGenerationEU program aims to support the recovery and resilience of all member states, but especially those that have been hit harder by the pandemic and have less fiscal space to respond. The program also seeks to address the structural weaknesses and imbalances of the EU’s economy, such as the low productivity and innovation, the high unemployment and inequality, and the incomplete single market and monetary union. The program could also help the EU to achieve its ambitious goals of becoming a global leader in the green and digital transitions, which are expected to generate new opportunities and benefits for the bloc’s economy and society.

The third opportunity is to enhance the EU’s political cohesion and solidarity, which have been strained by the rise of populism, nationalism and euroscepticism in recent years. The NextGenerationEU program could boost the public support and trust in the EU, by demonstrating its ability and willingness to act collectively and decisively in times of crisis and to deliver tangible and positive outcomes for its citizens and businesses. The program could also foster a sense of common identity and purpose among the member states, by reinforcing their shared values and interests and by promoting their cooperation and coordination on the key challenges and opportunities that they face.

The EU’s stimulus debt is a bold and unprecedented response to the Covid-19 crisis, which could have a lasting and transformative impact on the bloc’s economic and political future. However, the success of this response will depend on how the EU manages the challenges and seizes the opportunities that the stimulus debt entails.

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