ICAEW.com works better with JavaScript enabled.

COVID-19 prompts a step change in European public finances

21 May 2020: with most European countries now easing COVID-19 lockdowns, initial assessments are being made of the unprecedented impact on economic activity across the bloc. Critical decisions on funding for Europe’s post-pandemic recovery lie ahead, writes Susanna Di Feliciantonio, Head of European Affairs at ICAEW.

The deepest economic recession in the EU’s history

Recent Eurostat figures indicate the likely scale of economic collapse, with the EU economy predicted to contract by 7.5% this year, with unemployment rising to 9%. Rebound projections, suggesting growth of around 6% in 2021, remain very tentative with the risks – according to the European Commission – being ‘extraordinarily large and concentrated on the downside’.

The impact on public finances has been immediate. Fiscal deficits are expected to surge from an aggregate of 0.6% of GDP in 2019 to 8.5% of GDP in 2020. Having fallen to 86% in 2019, the euro area’s aggregate debt-to-GDP ratio is now expected to climb to close to 103% this year.

The steep increase reflects the kicking in of automatic stabilisers accompanied by the sizeable discretionary fiscal measures (approaching 3.25% of GDP) taken by governments across the EU. In the euro area, governments have provided extraordinary state guarantees for loans to businesses and other liquidity support for almost 24% of GDP. This is additional to liquidity support agreed at European level, amounting to 22% of EU GDP. Other EU budgetary measures account for a further 4.5% of EU GDP.

€3.4tn mobilised across the EU

Taking all European and national measures in aggregate, current estimates suggest that €3.4tn has been already mobilised across the EU. While the bulk has consisted of national measures, rapid action at European level has provided greater flexibility under EU rules for governments to act. Several decisions stand out as key.

The first-ever activation of the ‘escape clause’ in the European fiscal framework in March gave governments maximum leeway to take all necessary measures to tackle the pandemic and its impact. In Frankfurt, the ECB’s €750bn Pandemic Emergency Purchase Programme (PEPP), accompanied by other monetary and credit policy measures, has so far managed to help keep sovereign bond yields under control while preventing temporary liquidity shortages from evolving into a solvency crisis. Agreement, after some acrimony, on a Pandemic Crisis Support sitting under the European Stability Mechanism should enable euro area countries to tap credit lines of up to 2% of their GDP for direct and indirect healthcare costs. ESM support could eventually total around €240bn. 

EU state aid rules have been upended, clearing the way for Commission approval of over 150 national measures worth €1.95tn in support of businesses, including direct grants or tax advantages of up to €800,000 per company, subsidised public loans, deferrals of tax payments and social security contributions, wage subsidy schemes and (more recently) public recapitalisation of companies.

A panoply of other measures have been adopted. The European Investment Bank Group is working towards mobilising €200bn liquidity support for businesses, particularly SMEs. A temporary unemployment scheme (SURE) – signed off in 30 days – will provide €100bn in loans to countries to underwrite national short-time work schemes. Unused funds have been reallocated across the EU budget to fund a wide range of COVID-19 response related actions. By EU standards, the level of support and the number of initiatives agreed in a two-month period are unparalleled.

National or European recovery?

Real challenges lie ahead. The severity of and the response to the pandemic have been unequal. Recent state aid figures provided by the Commission clearly illuminate the difference, with over 50% of the subsidies approved initiated by Berlin, for a value of €994.5bn. This is far beyond the volume of measures being taken in France (€331.5bn), Italy (€302.2bn) and the (still in Brexit transition) UK (€78bn) – not to mention the remaining 24 countries. Such disparities could easily see existing divergences within the EU widening and deepening, creating an unlevel playing field within the internal market. 

Recognising that incomplete recovery in some parts could spill-over and undermine growth elsewhere, attention is now focusing on the nature of and funding for Europe’s economic revival. Central to such plans will be a new recovery fund within a revised EU multi-annual budget due to be published by the end of May. Arguments over how to raise and disburse funds – resurfacing some of the rancour seen during the 2010-12 sovereign debt crisis – highlight the fragility of stability, particularly in the euro area. 

A way ahead has been suggested by this week’s significant Franco-German proposal to enable common EU borrowing in order to provide recovery grants to the tune of €500bn to those hardest hit. The plan may not meet MEPs’ expressed desire for €2tn fund but it would still double the ceiling on the EU’s budget to about 2% of EU27 GNI. Importantly, such funds would fall under normal parliamentary scrutiny and be subject to standard financial controls. 

Not all countries are on board. The ‘frugal four’ (Austria, Denmark, The Netherlands and Sweden) are yet to accept any potential ‘communitisation of debt’. Central and Eastern Europeans, on the other hand, are concerned that they may lose out on future funding. With unanimity required for budgetary decisions, further concessions and compromises will be needed. These could well be linked to a strengthening of the EU’s economic coordination tools, revisiting specific tax policies while underpinning a green, digital and fair rebuilding of European economies. 

Timing for EU agreement on a recovery roadmap is tight. Failure to agree carries growing risks for European economic and political stability.