Macroeconomy

Boosting growth and making debt more sustainable through Next Generation EU

The EU’s recovery fund presents challenges as well as opportunities.

Nadia Gharbi, Pictet Wealth Management

Boosting growth and making debt more sustainable through Next Generation EU

In July 2020, EU leaders took an unprecedented decision to launch a recovery fund worth EUR750bn, labelled Next Generation EU (NGEU). To finance it, the European Commission will borrow an average of EUR150 bn per year between mid-2021 and 2026 on capital markets, with the borrowing set to be repaid by 2058.

The core element of NGEU is the ‘Recovery and Resilience Facility’ (RFF), worth EUR672.5 bn, of which EUR312.5 bn is in the form of grants and €360 bn are in loans. The remaining funds are split between six other programmes. To be eligible for the RFF, EU member states must present proposals for ‘investment and reform initiatives’ to be implemented before 2026. Each state must devote at least 37% of the funds they receive to climate-related objectives and a further 20% to digital initiatives.

Take-up of NGEU funds will probably be limited until 2022. The overall economic impact will depend as much on governments ability to use the money efficiently and productively as on how rapidly it is deployed, but NGEU should help countries, particularly in southern Europe, to boost their potential growth and make debt more sustainable. Italy and Spain will be the two largest beneficiaries of NGEU grants in absolute terms, while eastern and peripheral countries in general will be the main beneficiaries relative to GDP. The Italian government estimates that the investment plan it has devised to receive NGEU backing will boost GDP by 3.6 percentage points by 2026. In Italy and elsewhere, the boost to growth from NGEU could help countries with large debt burdens make those burdens more sustainable. Again, a lot will depend on the capacity of countries to spend the money they receive efficiently, particularly in peripheral countries.

The scale of the US's fiscal response has raised questions about whether Europe is doing enough. Policy packages are difficult to compare, especially if we focus on headline numbers. All in all, however, we should not underestimate Europe’s efforts. Giant fiscal stimulus in the US in some ways makes up for its lack of some of Europe's strong automatic stabilisers. Furthermore, apart from the NGEU, there have been several extensions to existing support measures throughout the pandemic.

The main differences between the US and Europe have to do with political commitment and mindset. Europe is not committed to continuous fiscal expansion beyond the pandemic. Furthermore, NGEU carries a lot of implementation risks. To close the EU’s output gap, a minimum condition will be making full use of the NGEU. 

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