Landmark EU deal may lead to better economic outcomes

After five days of intense negotiations, European Union (EU) countries have reached a deal on a huge coronavirus recovery package - a landmark agreement after years of discussion about who should pay for what within the EU’s budget framework and one that could lead ultimately to better economic outcomes for the region.
 
Significantly, the key components were kept unchanged, including the total amount at EUR 750bn. While grants only accounted for EUR 390bn - below the initial proposal of EUR 500bn - their inclusion nevertheless shows a significant commitment to those member states hardest hit by the crisis. And, there is no austerity conditionality embedded in the agreement.
 
Several compromises and ad-hoc solutions were required to get the deal over the line, including boosting rebates for the 'frugal four' and reintroducing rebates for Austria, reducing a number of programmes such as the Just Transition Fund, and cutting back spending on health, innovation and the solvency instrument to support the private sector. The latter will still be available to support European companies, but out of existing budgets.
 
Importantly, the governance of the Recovery Plan has been made more complex. While no member state has a veto to stop the distribution of aid to another member state, the newly adopted ‘super emergency brake’ gives any member state the power to oppose a recovery plan, requiring a decision by EU finance ministers or EU leaders. This could result in delays to disbursements. Some may be suspended altogether if there is evidence that countries have violated the rule of law.

Beneath the headlines, several countries got much of what they had hoped for, but there may be longer-term implications of the compromises made to get the deal done.
 
Poland and Hungary: The ones that got away
These countries will receive funding without more stringent conditionality around maintaining the rule of law, which is a win for them in the short term. However, they are unlikely to attract further long-term foreign investment at this stage. Other EU members felt it was more important to strike a deal to support Southern member states, than to expend too much political capital on these Eastern European countries. There will be some conditionality on the financing: if there is a breach, the matter will be settled by a majority of member states.

Italy and Spain: Grants linked to reforms
These countries will benefit from the balance between grants (EUR 390bn) and loans (EUR 340bn). The fact that the grants portion is higher than that of the loans is an expression of solidarity with member states worst affected by the virus. This has helped stabilize peripheral bond markets. The provision of grants will be linked to reform targets, however; if countries miss them, they won’t lose their entitlement to funds, but the European Council will review the situation.

‘Frugal’ countries: Got what they wanted, but at a price
The so-called frugals lead by Netherlands and Austria will get most of the rebates they asked for, but their previous opposition to the deal to please domestic audiences will impact bilateral relationships with Southern states in future. Economically, the rebates are not material enough to deplete EU budgets significantly.

Germany and France: Got their deal done, despite it all
For Germany and France, the most important goal was to reach a deal in time to rescue Europe from severe and lasting economic damage as a result of the virus. Navigating between the frugals and member states challenging European norms on the rule of law demonstrated the strength of the French-German relationship, which should help stabilise the bloc post-Brexit. It was an especially good result for Germany which holds the EU Presidency until the end of this year, though domestically the deal may not be universally well-received. 

Despite the compromises involved, the agreement on the Recovery Fund sends a strong political signal which could mark a new chapter in the Union's history. EU bond issuance will create a precedent which could become a permanent feature of the institutional framework going forward. With fiscal policy finally stepping up to facilitate the post-Covid recovery, the European Central Bank is no longer 'the only game in town'.

This powerful combination of monetary and fiscal policy, as well as the strong political will to ensure the EU's survival and success, now has the potential - perhaps more than ever - to lead to superior economic outcomes in the years ahead.