At the special EU summit in Brussels on March 6, 27 member states of the bloc decided to mobilize about 800 billion euros ($867 billion) for what the leaders described as necessary for the “rearn Europe.”
European Commission President Ursula von der Leyen was tasked with quickly resolving details on how members could help fund stocks in the effort.
At this point, EU countries appear to be able to fund around 650 billion euros in a package of 800 billion euros through their own sovereign debt, rather than joint EU borrowings.
The remaining 150 billion euros is expected to be loan assistance protected by the EU budget as BLOC moves one step closer to the concept of shared debt.
Unlimited debt
In Germany, waiting Prime Minister Friedrich Merz has already dumped his infinite mantra from the election campaign, and now, as he recently said, advocates for unlimited borrowing to fund “whatever it takes.”
To encourage other EU countries to follow a similar approach, von der Reyen wants to activate what she called the “escape clause.”
“This will allow member states to significantly increase their defence spending,” she said at the Munich Security Conference in February.
Jurgen Mattes, who heads the research unit’s international economics and economic outlook at the Institute for Economic Research (IW) in Cologne, Germany, believes that von der Leyen’s escape clause will help EU member states make their defence spending compatible for the so-called stability and growth of the Bloc.
Since 1998, PACT has set a public debt limit of 60% of GDP and a 3% fiscal deficit limit in 20 countries currently using the euro. However, although originally intended to prevent excessive national borrowing, many eurozone countries have repeatedly broken the principles.
If these countries need to assume additional debt to fund their military needs, EU leadership in Brussels will turn a blind eye rather than imposing penalties as they did previously.
Interest rates spread as warning signals
Softer implementation within the EU could potentially give governments more fiscal cockpits, but it remains to be seen whether financial markets are still confident. Financial market investors focus primarily on the country’s creditworthiness, which is reflected in the ratings assigned by specialized institutions. If the rating is poor, borrowing will be more expensive.
Germany pays a minimum interest rate on eurozone debt. The difference between German interest rates and other countries’ interest rates is called “spreads.” For example, Italy will have to pay a risk premium of 1.2 percentage points compared to Germany. That means you have to pay more for your debt.
The gap was even smaller at the start of the 2010 EU sovereign debt crisis, but soon surged to nearly 5% points. For Portugal and Greece, the premium was even higher.
The higher the interest rate, the less flexible the country is for other priorities, such as investment, education, and pensions. During the debt crisis, these imbalances pushed the eurozone on the brink of collapse.
The impact of the new defense-related debt on the spreads is “not yet clear,” Mattes told DW. He did not rule out the risk that individual Eurozone countries would undertake more debts than they would be responsible for under re-arming efforts.
Has the time come for Eurobond?
Large spending poses great risks. So is this the moment of joint borrowing through the so-called Eurobond?
The concept is simple. When European countries assume debt together, the terms of borrowing are advantageous over most countries when they issue debts individually. They will benefit from strong credit ratings in wealthy member countries. However, a wealthy country like Germany is responsible for the total debt raised through the EU’s joint debt.
This problem has divided the EU for many years, with fault lines running more or less along the north-south axis. Northern countries, including Germany, Austria, the Netherlands and Finland, have accused southern countries of finances, including France, Italy, Spain, Portugal and Greece of refusing to support their debts.
EU law also prohibits one country from assuming debts from another country. Article 125 of the Convention on the Function of the European Union expressly states this limitation.
Amendments to the EU treaty are necessary to use Eurobonds for defense funding. Such changes not only take time, but also require unanimous approval, which raises doubts about their feasibility.
However, the EU is already experimenting with collective borrowing, despite its limited liability.
For example, the 750 billion euro recovery fund, established during the 2021 Covid-19 pandemic, was the first time the EU has jointly undertaken debt. In this case, liability was limited to the proportion of countries in the EU budget. In other words, Germany was responsible for about a quarter of the total amount.
Similarly, the so-called European Stability Mechanism (ESM) and its predecessor, the European Financial Stability Facility (EFSF), were both joint debt forms, both as relief funds to support the hardships of the Eurozone countries amid the 2010 sovereign debt crisis.
Necessary, unlikely, or practical?
“We still don’t see if joint borrowing is necessary,” IW’s Mattes said.
Clemens Fuest, president of Munich-based IFO Institute, considers defence spending “highly unlikely” to be funded through shared debt.
“This measure is inappropriate because defence spending is a state expense and the EU must first develop a concept of defence policy. But for now, urgency is a priority,” Fuest told DW via email.
However, Jens Boysen-Hogrefe of the Kiel Institute for the World Economy (IFW) considers joint debt to be “practical” when funding shared military initiatives. However, in an interview with DW, he questioned that “all EU countries will fulfill their common defence commitment in the coming years.”
Boysen-Hogrefe believes that joint borrowing for European defense should also involve non-EU countries such as the UK and Norway to ensure that decisions are not subject to the EU’s unanimous principles. That would prevent countries like Hungary from using veto to stop progress. Furthermore, the European Investment Bank (EIB), co-owned by EU member states, can play a “significant role,” he said.
For now, details about how Europe will fund its development remain unclear, just as German Mertz will reconsider his solid opposition to the joint debt.
Last September, Mertz said he would “do everything in my power” to prevent the EU from “entering such a debt spiral.” He did not respond to DW’s request for comments on whether his position had changed.
This article was originally written in German.
