After one of the longest summits in EU history, leaders of the 27-member bloc eventually in the early hours of July 21 agreed on a historic rescue package as a response to the coronavirus pandemic, which has crippled not just European economies, but the major economies all around the world.
The recovery fund, to be composed of €390bn in grants and €360bn in loans, will be attached to a new €1.074 trillion seven-year budget, the Multi-annual Financial Framework (MFF), on which the heads of state and government also reached unanimous agreement, bringing the overall package to €1.82 trillion. On the surface, the deal looks like a positive development in EU member relations, but in reality it raises more questions than answers.
As ever in the crisis summits of recent times, German Chancellor Angela Merkel played a key part in getting the compromise deal within the individual countries across the line. For her personally this can be seen as another victory, but she has taken a lot of stick at home for the deal, which essentially has Germany on the hook if things go wrong in terms of the repayment of debts by the “weaker members” of the Union. And let us not forget that Merkel as things currently stand, is set to step down from office in October of next year. Her departure will in my view be a huge loss for the bloc and will raise serious questions about the future of the EU, especially if she is replaced as Chancellor by a hard-line budget disciplinarian. And make no doubt about it, the “Club Med” countries, traditionally seen as the weakest link in terms of adhering to the EU’s budgetary rules will get a difficult time if they do not manage to pay back their debts and/or fail to implement much-needed economic reforms, pandemic or no pandemic.
The whole idea of whether the new money being made available should be in the form of grants rather than loans has been a thorny issue. But here I have some sympathy for the likes of Italy, one of the worst hit in terms of lives lost and damage caused to its economy. The virus was not its fault, and as such I believe it should be given some slack in terms of how much new debt it is being forced to take on. However, one always gets the feeling that the politicians in Rome don’t fully have the trust of their peers in the other key EU member states. Clearly, “there is something rotten in the state of Denmark” and indeed in the other countries of the self-declared “Frugal Four”, Austria, the Netherlands and Sweden. They strongly opposed the idea of taking on debt to issue recovery grants, and for much of the tense summit, they fought a fierce battle to reduce the portion of grants in favour of loans. And in the end they won some big concessions, including a significant increase in the rebates that are used to cap their overall contributions to the EU budget. And Dutch Prime Minister, Mark Rutte, in particular, looks like taking up the mantle of policing the deal. Germany might seem to be going soft on budgetary discipline but the Netherlands certainly isn’t.
Then there was the spat with Poland and Hungary about these countries having to adhere to the EU’s democratic process, which again left a sour taste in the mouth. Budget deal or not, all is not well within the EU. There are still many uncertainties about the long-term future of the bloc. I can see the two afore mentioned Eastern European countries following in Britain’s footsteps, and leaving the Union in the coming years. They may wait to see how Britain performs economically over the next decade before deciding to jump ship, but I still believe it is only a matter of time. My core view remains the same that the EU in its current form will no longer exist come the end of this century. Relationships are only likely to become more fraught as the years go by, and who will take over the “conciliatory” role when Angela Merkel is gone?
As to whether the huge amount of EU stimulus (both fiscal and monetary) leads to the desired economic recovery, only time will tell. There is still talk of a “second wave” of the virus, and against that background, consumers are likely to remain cautious, at least until a vaccine is found. So as such, I would say the recovery in the short-term is likely to be weaker than most current predictions. In terms of a potential big uptick in inflation, my gut feeling is that price developments are more likely to surprise to the upside than the downside in the short to medium-term, but maybe not enough to warrant a significant increase in ECB interest rates, and I still wouldn’t entirely rule out the possibility of stagflation. As regards bond yields, geopolitical risks more than economic ones will determine how they play out in the next few years, but clearly the picture of increased tension at government level within the EU that I have outlined, would be negative for yields, pushing them higher.
From Ireland’s perspective, the new EU budget deal has some positive and negative developments. The country will be the main beneficiary of the €5bn “Brexit Adjustment Reserve” which will offer funds for the sovereigns and sectors worst-hit by the effect of Britain leaving the EU. But the new seven-year agreement represents funding cuts for many sectors, including agriculture. According to the Irish Farmers’ Association (IFA), the overall funding allocation for the Common Agricultural Policy (CAP) is down 9% (at constant prices), compared to the previous seven years.
All in all, many challenges lie ahead both domestically and on the international stage. For now, it appears that most EU member state are singing from the same hymn sheet, but one false note is all it will take for a less harmonious tune to be ringing in our ears.
Author: Alan McQuaid is a leading economist and media commentator in Ireland. He has worked with the Department of Finance and the leading Irish stockbroking companies.