Towards a Common EU Debt: Where Do We Stand?

We are in a historical moment where Europe has reached a certain maturity in policy choices at the common level and has tested different policy instruments and interactions across countries. Without being an exhaustive list, the European Union and the euro area have experienced since the inception:

• common fiscal rules (the Stability and Growth Pact)
• the adaptation of state aid rules to crisis situations
• the resolution of several EU country crises during the sovereign debt crisis, with bilateral loans and supranational funding facilities (the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM))
• the start of the banking union (the Single Supervisory Mechanism and the Single Resolution Mechanism, although the European Deposit Insurance Scheme component is still missing)
• the implementation of unconventional monetary policy instruments, including what is often labelled “quantitative easing”.

The 2020-2021 pandemic crisis represented an inflexion point in supranational borrowing. With the European instrument for temporary Support to mitigate Unemployment Risks in an Emergency (SURE) of up to €100 billion, and notably with the NextGenerationEU (NGEU) and its core component, the Recovery and Resilience Facility (RRF) of up to €723.8 billion, the EU has reached another milestone. Since 2020, the European Commission (EC), on behalf of the EU, began issuing EU debt on a large scale to fund these temporary programmes via grants and loans. These programmes were launched in addition to the long-term EU budget for 2021-2027 (€1,211 billion), which is funded via national contributions.

This has several implications. First, it is the first time that the EC aims at providing a joint fiscal effort on a meaningful scale, thus complementing the ECB’s monetary response to the pandemic shock. Second, this makes the EC a major (temporary) issuer of government borrowing in euros worldwide. This brings the EC into a prominent place in the landscape of supranational euro debt issuers, together with the EFSF/ESM and the European Investment Bank (EIB).¹ The NGEU programme could lead to a new net borrowing activity above €700 billion by the end of 2026. Third, this initiative provides a substantial amount of burden sharing between countries. There is a solidarity element for the first time with a substantial grant component (direct transfers) in the equation that could serve as a catalyst towards a common fiscal capacity if successfully implemented.

With the latest economic and geopolitical developments, there is a renewed interest by policymakers and academic researchers in the possibility of joining forces to go beyond the national goods to European goods. Moreover, the EMU is still incomplete, and the idea of a permanent countercyclical fund for shock absorption is still being debated. There are many angles to be analysed about the possibility of creating a permanent common fiscal capacity, ranging from the legal aspects to the political economic arguments and moral hazard. Much of the past debate has focused on the role of fiscal rules and fiscal discipline and the compliance with the SGP. Either way, further integration would require additional funding. According to one view, a possible roadmap might include the continuation in some form of the NGEU project beyond its end in 2026, towards a more permanent central fiscal capacity. This may play a role in enhancing macroeconomic stabilisation and convergence in the euro area in the longer run. This view, however, is not reflected in the current policy agenda.

Against this backdrop, this article explores some aspects surrounding the idea of EU borrowing. It first focuses on the concept of EU debt and then elaborates on some related concepts, including considerations around the guarantees and feasibility of a common EU debt. Third, it points to some aspects relevant for the creation of a permanent common fiscal capacity, which would also entail the issuance of common EU debt. Finally, it then discusses what purposes could justify continued borrowing beyond 2026.

Common EU debt: Where do we stand?

The concept of common EU debt is an aggregated statistical construct obtained by adding the debt of individual member states. A key measure is the “Maastricht debt” (also known as EDP (Excessive Deficit Procedure) debt), which is the outstanding gross debt (defined as currency and deposits, loans and securities other than shares) at nominal value and consolidated between and within the sectors of general government (Lojsch et al., 2011). This covers the general government sector of the member states, intergovernmental lending and the EC as it possesses tax redistribution power and capacity to issue debt. The EC has been issuing bonds to support different EU policies for the last 40 years,² but it only became a prominent debt issuer as of 2020.

On 22 October 2023, Eurostat published the aggregated EU debt, which amounts to €16 trillion or 91% of GDP (the euro area debt amounts to around €13 trillion or 90.9% of GDP). This figure accounts for loans provided by the EFSF/ESM to the beneficiary member states (i.e. Ireland, Greece, Portugal, Cyprus and Spain) and the RRF loans once payments have been finalised. Borrowing in the markets undertaken by the EC to finance the RRF grants is also considered EU debt.³ However, the debt issuance associated with the past funding of the RRF grants is not reflected yet in the national and EU debt aggregates of 2021 and 2022, pending future Eurostat publications.

Focusing on the supranational new net borrowing activity from the EC, which is part of the EU debt, Figure 1 shows that around €375 billion have been raised from several new EU bond issuances over 2020-2023. This issuance activity compares with the €78 billion of new securities issued over 2009-2019. The EC has issued mostly long-term EU bonds (around 70%). The main uses of the common pool have been to finance SURE (€98.4 billion) and the RRF. The disbursement process is well on track as the member states are receiving their funds when requested. The disbursement proceeds from the RRF facility are directly transferred to the member states, while the non-RRF funds are transferred to the EU budget. The EC has already disbursed to EU member states around €174 billion, with around two-thirds of disbursements in the form of RRF grants. The main beneficiaries of the RRF funds by now are Italy (€85.4 billion), Spain (€37 billion), France (€12.5 billion) and Greece (€11.1 billion).

Figure 1
EU debt by the European Commission, 2020-2026

New bond issuance and uses (2020-2023) and commitments (2020-2026)

From an operational perspective, the EC moved from the back-to-back funding typically used to fund previous lending programmes to a new diversified funding strategy for the NGEU. The main difference is that it decouples the timing, volume and maturity of the borrowing transactions from the timing of the reimbursement of funds (European Court of Auditors, 2023). The rollover profile ensures a smooth repayment profile. Most of the debt to be issued will be long-term debt, and repayments (of debt and interest costs) are expected over 2028-2058. The final borrowing cost is unknown at the moment, but the prospects are good (e.g. Claeys et al., 2023), given some considerations: i) the cost of funding in the short term is increasing with the nominal interest rates, ii) the borrowing cost of the EU debt is still above that of Germany and France (but below that of Spain and Italy), and iii) the market liquidity of the EU bonds is not as high as, for instance, the German bonds. Some reasons might be linked to the defined duration of the EU bond issuance with a clear cut-off date by the end of 2026 and that investors may deter to include EU bonds in their long-term investment strategies (e.g. Bletzinger et al., 2023).

The current debate centres around the concept of debt sustainability analysis (DSA) and the ongoing European governance reform package, which also tackles the government debt angle. One of the expected consequences of the RRF design is that by improving, ceteris paribus, growth prospects and lowering the cost of financing (implying some interest savings), the RRF will help to somewhat mitigate debt sustainability concerns in vulnerable countries and may provide more fiscal space for economic stabilisation in the future (Freier et al., 2021). In the countries with high debt-related risks, it is also key with respect to reducing the stock of government debt through more favourable economic conditions and improved quality of public finances.

From the DSA perspective, country-specific concerns have improved in the highly indebted countries. The channels accounted for in the DSA are a combination of favourable risk premium effect, the impact of the fiscal stimulus on growth and inflation, and the effect of structural reforms on potential output. Overall, it is estimated to have the potential of reducing the government debt ratio by around 14 percentage points of GDP in Spain and 12 percentage points of GDP in Italy by 2031 (Bankowski et al., 2022). These favourable debt trajectories will depend on the future evolution of interest rates and on the timely and efficient implementation of the reforms and investment plans outlined in the RRPs.

Towards a permanent common fiscal capacity:
Allocation vs. stabilisation

In brief, there are two main purposes for making the case for a permanent central fiscal capacity: allocation of resources and stabilisation of the economic cycle.

The temporary NGEU is a mix of both objectives, as its resources are mainly used to support structural reforms and the investment capacity towards the green and digital transitions (mainly via direct government investment and capital transfers to the private sector). The component of stabilisation comes from the possibility to respond counter-cyclically to an economic shock (e.g., the COVID-19 crisis or an energy shock). Moreover, the countries that were most hit, Italy and Spain, receive the most funds, pointing to an element of solidarity.

Currently, there is a discussion ongoing on the need for centralised financing of common EU investment needs (e.g. Panetta, 2023; Draghi, 2023). This could range from defence and migration to economic challenges such as ageing populations – with the associated costs in pensions and health care – or the centralisation of purchases of raw materials. A related concept is the European public goods (EPGs), that entails, among other features, both common EU financing and the joint production of goods (Buti et al., 2023). The experience of the NGEU shows that less than 5% of the investment projects are cross-national in nature: in other words, the projects funded by the EU are mostly nationally produced and, therefore, would not qualify for EPGs.

The key question is whether we could converge towards the provision of more common public goods. European governments spend, on average, the highest amounts of funds in the world (in percentage of GDP) for the provision of public goods and services. Yet, there are different preferences and fiscal capacities. Figure 3 shows how the EU, the euro area and selected countries spent their budgets in different economic functions. The main function is redistribution, with social protection (including pensions) being the largest component of public expenditure in all countries, amounting to 21% of GDP on average. Pension payments represent around 60% of this expenditure on average. Other priorities (although with different national preferences) are health, economic affairs and education. In contrast, most of countries spent the lesser resources in defence (1.3% of GDP) and environmental protection (0.9%) in 2021. Some of these goods and services could be eventually brought at the European level, with the subsequent issuance of more common EU debt.

On the other hand, a permanent fiscal stabilisation capacity is still missing in the Economic and Monetary Union (EMU) architecture. The idea put forward by several researchers and commentators is to introduce a permanent counter-cyclical central capacity to respond in cases of economic country-specific shocks – or common shocks with asymmetric effects across countries – when national fiscal stabilisers are impaired or when countries face difficulties to borrow on financial markets (e.g. Beetsma et al., 2021). This concept has been largely debated in academia and in European fora, with contributions from the macroeconomics and political economy literature. The discussions on the trade-offs of a permanent common fiscal capacity and its optimal size are beyond the scope of this paper, but some momentum might emerge in view of the recent developments. Regarding the potential moral hazard argument, a push factor would be the implementation of an improved fiscal governance framework in the EU as of 2024. Concerns over the possible generation of permanent transfers among countries, could be partly alleviated by the NGEU programme being a success story and by introducing safeguards in the design of the central fiscal capacity itself. For example, transfers – for each country – could be calibrated to deviations from historical growth, not on growth differences between countries (see, e.g. Beetsma et al., 2022). The non-repayable part (transfers) constitutes around half of the total envisaged NGEU envelope, which implies a step forward in cross-country risk sharing at the EU level. A possible permanent common fiscal capacity would likely be limited to euro area countries, instead of the EU. One of the main arguments is that euro area countries do not have the possibility to use their national currency to devaluate in case of major economic shocks.

Finally, another related important angle is the role of the central banks as lenders of last resort, which is explained in Girón and Rodríguez-Vives (forthcoming). Figure 4 shows the combined leverage response in the euro area over 2007-2022. It is clear from the figure that the contribution of the Eurosystem to the combined euro area fiscal-monetary policy response (measured in leverage) has increased over time. The ECB has supported the ability of national fiscal policies to stabilise the cycle beyond automatic stabilisers in the presence of increases in sovereign spreads.⁷

Conclusions

A precondition for thinking beyond the 2026 deadline for more EU common debt would be that the NGEU programme is perceived overall as successful from different perspectives, ranging from the operational borrowing performance to the materialisation of the macroeconomic expected impacts.

The effectiveness of the NGEU will crucially depend on a timely and effective implementation of the RRPs. However, it is too early to assess the implementation. Implementation risks relate to possible lower-than-expected absorption capacities, with the substitution of productive investment expenditure with consumption/social expenditure, or the possibility that the investment targets are not fully met by 2026. A careful monitoring and implementation of the reporting and review mechanisms in place at the European and national level is key for the success of the NGEU project. The European Court of Auditors has been relatively positive in its initial assessment over the 2021-2022 implementation. In 2024, there will be an audit to assess the mid-term review of the programme, which will be key for public trust in this novel policy instrument.

In view of the current developments, choices on how to better allocate public resources are becoming even more crucial. New economic and geopolitical challenges are impacting national and EU budgets (e.g. digitalisation trends, climate change, deglobalisation trends, defence expenditure, war in Ukraine), while several countries face increasing challenges (e.g. immigration, energy supply costs, high stock of debt, ageing populations). Looking ahead, the urgency of further sharing the public goods and burdens across EU countries may increase. Moreover, the higher frequency of economic shocks may justify the room for a permanent joint rainy fund and accelerate the process of completing the EMU.