Don’t be tricked by EU Re­cov­ery Fund’s con­jur­ing act

Pan­demic stim­u­lus plans threaten new di­vides within the bloc, de­spite their grand rhetoric

The Daily Telegraph - Business - - Business Comment - AM­BROSE EVANSPRITC­HARDD

The EU’s Re­cov­ery Fund has taken on a sacral char­ac­ter out of all pro­por­tion to its macroe­co­nomic sig­nif­i­cance. The week­end gath­er­ing of EU elites at France’s Cer­cle des Economiste­s was one long cel­e­bra­tion of this pan­demic pack­age.

I did not hear a sin­gle par­tic­i­pant se­ri­ously ques­tion whether this clut­ter of mea­sures – os­ten­si­bly worth €750bn (£673bn) but stretched thinly un­til 2025 – will make any ma­te­rial dif­fer­ence given the scale of the Covid shock, or whether its struc­ture will pre­vent the eu­ro­zone’s north-south gap widen­ing fa­tally as an asym­met­ric re­cov­ery takes hold.

That shock is im­mense. The IMF has slashed its fore­cast for 2020 yet again to -12.2pc for France, and -12.5pc for Italy and Spain even as­sum­ing a be­nign sce­nario and no sec­ond wave. They will claw back just half the lost ground in 2021. Po­lit­i­cal ef­fects will hit with a de­lay as job sub­si­dies wind down.

Gita Gopinath, the IMF’s chief econ­o­mist, drew up th­ese fig­ures af­ter the out­lines of the EU’s Next Gen­er­a­tion Re­cov­ery Plan were al­ready known, so clearly she does not be­lieve the “game-changer” rhetoric.

The Re­cov­ery Fund is cer­tainly an in­sti­tu­tional coup for the Euro­pean Com­mis­sion. The Ber­lay­mont will sud­denly be able to bor­row large sums on the bond mar­kets and will con­trol the way the money is spent. But be care­ful: it is a one-off. It does not im­ply fis­cal union or eu­robonds, and is best un­der­stood as a Ger­man ma­noeu­vre to head off such a con­sti­tu­tional rev­o­lu­tion. A Hamil­ton mo­ment it ain’t.

Nev­er­the­less, the per­ma­nent bu­reau­cracy in Brus­sels will gain fresh levers of pa­tron­age and po­lice pow­ers. This mat­ters in EU es­cha­tol­ogy. But in im­me­di­ate terms, it is nei­ther a New

Deal nor an au­then­tic eco­nomic re­birth. Stripped of dec­o­ra­tion, the pure fis­cal com­po­nent (grants) amounts to €100bn a year for the whole EU, or 0.6pc of GDP an­nu­ally. This will be spread around, af­ter much horse­trad­ing and with po­lit­i­cal strings at­tached, and will have al­most noth­ing to do with the pan­demic once the funds are ac­tu­ally dis­bursed.

The de­tails so far sug­gest Poland, Hun­gary and the east bloc will be the big­gest re­cip­i­ents per capita – to buy them off. Some of the money will go to French and Ger­man re­gions. Italy will re­ceive a mod­est net trans­fer for four years but it will be barely no­tice­able when set against the greater drama of its debt dy­nam­ics, a ra­tio rock­et­ing past 160pc of GDP even if all goes well.

Hence the grow­ing talk of a debt re­struc­tur­ing con­fer­ence once the cri­sis is over – akin to the post-War London Ac­cord of 1953 – in or­der to hair­cut Ital­ian and Club Med debt. Caveat cred­i­tor. No funds will ar­rive be­fore next spring. In the mean­time, Italy must cover a bud­get deficit head­ing for 14pc of GDP this year. The Ital­ian trea­sury must find an ex­tra €120bn to €150bn to cover the short­fall up to De­cem­ber. Not even the Euro­pean Cen­tral Bank can mop up this much debt so quickly with­out de­vi­at­ing promis­cu­ously from its “cap­i­tal key”, and pro­vok­ing fresh com­plaints at the Ger­man Con­sti­tu­tional Court. “Who is go­ing to buy the pa­per?” asks Lorenzo Codogno from LC Macro.

Nor is the Re­cov­ery Fund agreed in any case. The “fru­gal five” (count­ing Fin­land) are play­ing for time. They may well block a deal at next week’s EU sum­mit and try to push talks into the au­tumn, hop­ing that a V-shaped re­cov­ery will by then have changed the po­lit­i­cal mood. “I don’t think we need this crazy hurry,” said Mark Rutte, the ul­tra-hawk­ish Dutch pre­mier. There may well be signs of such a re­cov­ery by then, but whether it is an il­lu­sion or the real thing de­pends whether you be­lieve the mon­e­tarists (su­per-bullish) or the New Key­ne­sian es­tab­lish­ment (much less san­guine). It is a defin­ing the­o­ret­i­cal de­bate. “I am wor­ried that peo­ple are go­ing to see the num­bers in the short run and think things are just fine,” says Olivier Blan­chard, for­mer chief econ­o­mist at the IMF and doyen of the global Key­ne­sians.

He warns of a “trun­cated V” in Europe that stalls af­ter re­gain­ing two thirds of lost out­put, fol­lowed by a treach­er­ous hia­tus be­fore a vac­cine ar­rives. There are some hints of this al­ready. Ger­man in­dus­trial or­ders did not roar back as ex­pected in May. They are still down 31pc from the pre-Covid peak, and down 52pc for car man­u­fac­tur­ing. The 15,000 job losses an­nounced by Air­bus are a fore­taste of what may be com­ing.

Weak in­dus­trial or­ders mat­ter more than surg­ing re­tail sales as an in­di­ca­tor at this junc­ture. Pent-up de­mand has in­flated pur­chases. Will spend­ing hold up as job sub­si­dies run down and un­em­ploy­ment bites? I doubt it.

As for Holland’s Rutte, his ne­go­ti­at­ing de­mands are dra­co­nian. There should be no fis­cal trans­fers, just loans, and th­ese must be rig­or­ously con­trolled. Any aid to Italy and Spain – or the east Euro­peans – must be con­di­tional on “deep re­forms to pen­sions, labour mar­kets, ju­di­cial sys­tems and tax­a­tion”.

His tone has caused pre­dictable fury in Rome. He seems never to have pro­gressed be­yond the dis­cred­ited moral­ity tale of 2011-15, when the eu­ro­zone’s bank­ing cri­sis was mis­di­ag­nosed as a Club Med debt cri­sis, and when Italy was sub­jected to aus­ter­ity overkill by EU com­mis­sars.

Chan­cel­lor An­gela Merkel is now try­ing to per­suade Italy’s Giuseppe Conte to ac­cept a “Troika-lite” regime, mean­ing a for­mal re­quest to the EU bailout fund (ESM), along with pen­sion re­forms to pla­cate the fru­gal five.

This has put Conte in an ex­cru­ci­at­ing po­si­tion. His Five Star pa­trons know that an­ni­hi­la­tion will fol­low if they ac­cept such con­di­tions.

If the EU is not care­ful, its pan­demic plan will end up caus­ing an Ital­ian po­lit­i­cal cri­sis and there­fore a debt sol­vency cri­sis, set­ting in mo­tion the very events it most fears.

By all means buy risk as­sets as a bet on global mone­tary re­fla­tion (though per­son­ally I am wait­ing), but don’t be be­guiled by the trans­form­ing magic of the EU Re­cov­ery Fund.

‘If the EU is not care­ful, its pan­demic plan will end up caus­ing an Ital­ian po­lit­i­cal cri­sis and there­fore a debt sol­vency cri­sis’

A worker at an Air­bus fac­tory in Ham­burg, Ger­many. The com­pany has an­nounced it is to cut up to 15,000 jobs

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