On July 21, after five days of hectic, and sometimes bad-tempered, discussions, the 27-member European Union reached a historic agreement to counter the debilitating effects of coronavirus on the region’s economies.
The EU’s GDP is set to contract by close to 8 per cent in 2020 thanks to the Covid-induced disruption, even as the Covid death toll has crossed 130,000. This has been harrowing for investors, especially as many countries, such as Italy, Spain and Portugal, were in poor financial health going into the crisis.
There are three chief elements of the agreement. One, a Euro 1.1 trillion budget for the EU over the next seven years. Two, Euro 360 billion in low-interest loans for countries most hit by Covid-19. Three, Euro 390 billion in grants to the worst affected economies.
What is so special?
The recovery package stands out for a variety of reasons.
One is, of course, its size — roughly $2 trillion or Rs 150 lakh crore or 75 per cent of India’s annual GDP.
Secondly, instead of individual countries raising funds, this time around, the EU as a whole will borrow money from the markets — a total of Euro 750 billion (for grants and loans). This is a radical departure —economically as well as politically — from the past.
Given the size and scope (EU assuming debt on behalf of member states) of this deal for a “new generation EU”, many observers have called it “Hamiltonian”. The reference is to Alexander Hamilton, the first US Treasury secretary (his face is on the $10 bill), who had the federal government absorb the debts incurred by all the states during the Revolution.
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Thirdly, the EU will be able to impose taxes in the region to partially pay for the fund. This, along with the Budget details, will entail an unprecedented level of fiscal coordination among the member states for the next seven years.
Fourthly, almost a third of the overall package — Euro 500 billion — has been earmarked towards countering climate change. This includes expenditure towards developing clean energy, its use via emissions-free cars and other such technologies, as well as promoting energy efficiency.
What are the implications?
In terms of the EU’s GDP, this agreement’s size is roughly 5 per cent. Given that the economy is likely to contract by more, this deal is just the first step in terms of resuscitating the ailing economies of the region. Not to mention the fact that this deal still requires member states to ratify it.
Even after ratification, implementation will be another kettle of fish, because many countries such as Hungary and Poland may resist the reforms agenda that many of these grants and cheap loans might entail.
However, the political significance of the deal cannot be overemphasised.
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The Global Financial Crisis of 2008-09 and the efforts undertaken in the EU for economic recover exacerbated differences between better-off EU economies such as Germany and the worse-off ones such as Greece. Weaker economies were asked to cut back expenditures and raise taxes to meet the onerous austerity requirements of paying back loans. This resulted in massive political push back across many countries.
Over the past decade, euro-scepticism has led to several populist leaders – both on the extreme Right and the extreme Left – in EU member states gaining ground. The UK’s shock decision to leave the EU in 2016 was part of this very trend.
More than saving the economy of the EU, this deal saves the political idea that is the EU. That’s because it has been concluded despite significant differences among a whole host of countries.
To begin with, it has been made possible by a Franco-German understanding not seen for at least a decade. While French President Emmanuel Macron has been pushing for boosting fiscal firepower — to undermine the rising tide of populism in all EU countries — German Chancellor Angela Merkel has been opposed to measures that would be seen as “handouts”.
Germany is not the only one. Along with the “frugal four” (Austria, Denmark, the Netherlands and Sweden), Germany has been opposed to massive borrowings that would have the taxpayers paying back for decades. To be sure, under the current arrangement, the borrowings would be done by 2023 and paid back by 2058.
On the other hand are economies such as Italy and Spain, which are most severely hit, urging for a less onerous recovery package.
This deal is “historic” because it allows — albeit for just this once — a debt mutualisation (collective debt) that austere member states like Germany have abhorred in the past.
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How is this different from the EU response to the 2008-09 crisis?
In the aftermath of the 2008 crisis, several EU countries found that, thanks to high levels of national debt and their abysmal sovereign rating, they could not raise loans from the markets at affordable interest rates.
So, the EU had created the European Financial Stability Facility (EFSF), which essentially worked as an intermediary between the investors (who got more security for their investment) and the heavily-indebted EU countries (who got loans at lower rates).
The EFSF and the European Stability Mechanism, which succeeded it in 2013, together disbursed Euro 255 billion in loans.
The current structure is significantly different in that it allocates nearly Euro 400 billion in grants, apart from Euro 360 billion in loans. Moreover, the loans do not come stapled with demands of fiscal austerity — they are likely to ask, however, for certain basic rule of law to be adhered to.
How does this compare with what India is doing?
The key deficiency in India’s Covid relief package (roughly 10% of GDP) is the inadequate fiscal (or government) spending (just 1% of GDP). For spending more, Indian government would have to borrow more. However, without substantially higher spending, the economy will likely struggle for longer.
The key component in the EU package is the Euro 390 billion of grants. Cheap loans and credit guarantees are useful but in a falling economy and with acute economic stress in the MSME sector, grants and wage subsidies might be more useful.
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