The rising debt of the European Union (EU; AAA/Stable) will help to finance member states’ growth strategies while adding to their future EU budget contributions and contingent liabilities, Fitch Ratings says. The rise of members’ commitments to provide financial support to EU supranationals underscores the role of crises in promoting financial risk-sharing in the EU.
The EU ramped up borrowing in response to Covid-19, raising EUR90 billion for the SURE short-term work scheme. This summer it began issuance for the Next Generation EU (NGEU) recovery fund, and plans to issue up to EUR750 billion in NGEU-related debt, or EUR150 billion annually until 2026. This would transform the EU into the largest EU supranational borrower, although it would still borrow less than major EU sovereigns.
We view NGEU grants and loans to fund ‘recovery and resilience’ programmes as a key plank in net recipients’ growth strategies, which could have a substantial positive impact on medium-term growth prospects. This will depend on countries’ institutional capacity to deploy the funds in a timely and efficient manner and implement the reform agendas in their programmes.
Issuing common debt to fund budgetary grants to EU member states is a significant step in fiscal risk-sharing as debt will be repaid from common resources rather than by the beneficiary. Plans to partly repay EU debt by raising new taxes at the EU level would deepen fiscal integration. The NGEU template of EU market borrowing and potential greater revenue centralisation could set a precedent for future crises or downturns, enhancing the EU’s institutional framework.
However, integration and risk-sharing remain contentious and it is unclear whether voters’ attitudes towards increased use of common taxes have fundamentally changed. A European Council on Foreign Relations survey suggests appetite for risk-sharing declined in major EU countries during the pandemic.
The EU’s ‘AAA’ rating is resilient to the debt increase as the agreed increase in potential budget contributions from member states, which raises the EU’s ‘own resources ceiling’ to 2% of GNI from 1.2%, should ensure coverage of EU debt service by potential additional contributions from ‘AAA’ member states over the long term. Continued willingness of member countries to provide financial resources to the EU is a key element in our analysis. A weakening assessment of the propensity to support could have negative rating implications, as could a downgrade of one of the largest ‘AAA’ rated EU member states.
Higher EU debt to fund grants has fiscal implications for member states, as it will be repaid via the EU budget (and hence by EU sovereigns according to their share of EU budget financing). However, spreading repayments from 2028 to 2058 means the impact on sovereign balance sheets in any given year will be small.
Earlier crises increased EU risk-sharing, for example via the European Financial Stability Facility (EFSF; AA issue rating) and then the European Stability Mechanism (ESM; AAA/Stable). Intra-EU financial support and risk-sharing mechanisms are reflected in the large financial commitments by EU sovereigns to support EU supranationals, via potentially higher EU budget contributions, guarantees of EFSF debt, and callable capital subscribed to the European Investment Bank (EIB; AAA/Stable) and the ESM.
These commitments will average 11% of each country’s GDP by end-2026 assuming full debt issuance under the NGEU, much larger than elsewhere in the world. Eurostat accounts for EFSF guarantees in its general government debt figures, but not callable capital subscribed to the EIB or ESM, or future EU debt repayment. We view these as a rising contingent liability for EU sovereigns. However, EU supranationals’ high ratings limit the likelihood they materialise into disbursements.
Source: Fitch Ratings