The fund, and the “next-generation” union that it represents, could be a game changer from both an economic and political perspective. Last year, European Union leaders agreed to launch a €750 billion (5.5% of EU GDP) Recovery Fund to kick-start post-COVID-19 economic growth.
The multiyear spending program is an important political step forward for a previously divided Europe. As noted in Yanick Loirat’s recent NB Blog, for the first time in its history, the EU will be able to borrow large block amounts in international markets to boost growth. The program is designed to target the economies most affected by COVID-19 and the lion’s share of the package (€390 billion) will be distributed in the form of grants to be repaid from the EU budget. On a net basis, the greatest beneficiaries will be peripheral and Eastern European countries, while the largest repayment contributions will come from Germany, France and the “frugal” countries (Austria, Denmark, the Netherlands and Sweden).
The main rationale behind this fiscal transfer framework is to help boost highly indebted economies without driving their public debt to unsustainable levels. In addition to the grants, low interest loans (€360 billion) are also available to the countries with higher-than-EU-average costs of borrowing. The loans must be repaid by the individual counties but can serve as an alternative to local sovereign debt issuance. If that occurs, smaller local issuance could potentially put downward pressure on peripheral yields relative to core and semi-core rates over the course of the recovery plan.
In our view, the overall growth impact from the Recovery Fund will depend on institutional capacity to efficiently absorb the funds; factors include the number of new initiatives/projects and how swiftly they can be executed. On the EU level, economic growth is expected to reach between 0.5% (less optimistic scenario) to 1.5% (more optimistic scenario), peaking around 2022 – 2023. Higher growth of 0.8% to 3% is expected from peripheral countries that would receive a higher portion of fund proceeds.
As the main pillar of the EU’s Green Deal, the Recovery Fund will likely focus considerable effort on the green/digital transitions, and help the EU with its objective of becoming climate neutral by 2050. In our view, this presents a number of investment opportunities, particularly in clean tech and renewables, electric vehicles, energy efficiency, digitalization and cloud technologies. Key sectors that could benefit from the projects include capital goods, tech hardware, utilities, autos and telecom.