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Budgetary issues are soon to be front and centre in European politics

Budgetary issues are soon to be front and centre in European politics

State aid reform within the European Union is currently being discussed, with many member states preferring a two-pillar approach that would also involve the bloc engaging in new common borrowing. They worry that if state aid rules are loosened too much, it will unfairly benefit German industry, which would be a blow to the principle of a level playing field at the heart of the European Union’s single market.

European Commissioner Thierry Breton has proposed a “Sovereignty Fund” to address this issue, with commissioners and member countries essentially splitting into three camps: those who oppose any relaxation of EU state aid rules but are willing to go along with them if they are targeted and temporary; those who favour a substantive relaxation of the state aid framework but oppose common borrowing (Germany); and those who support a compromise between the two (the Nordics) (France).

Unexpected alliances have formed as a result, including one between the north and the south: Italy has sided with the Nordic countries because it doesn’t think more common borrowing is on the table.

Berlin’s role, as always, will be decisive.

Olaf Scholz, chancellor of Germany, has approved a midterm review of the EU budget, which will begin in earnest this summer. This review is necessary to win over member countries concerned about Germany’s superior fiscal firepower. If other member countries are unyielding, the Chancellery may have a hard time securing permanent flexibility in the state aid regime.

In the meantime, Germany has supported a package of measures meant to fill the funding gap, including the redeployment of the roughly €136 billion in unused Recovery and Resilience Fund (RRF) loans to fight the IRA. Loans guaranteed by the European Investment Bank could be included in the policy mix, calming the nerves of member countries intent on maintaining parity.

However, neither of these things will be simple or straightforward, and a serious mid-term review of the Multiannual Financial Framework — and especially more common borrowing — faces significant opposition both within and outside of Germany.

Christian Lindner, finance minister for the Free Democrats (FDP), is a major adversary. The credibility of both Lindner and the FDP as the defender of sound public finances has been damaged by a significant increase in government spending, and so he wants to make sure the government sticks to its agreement on no additional common borrowing, despite having already made several concessions to his coalition partners, especially on domestic fiscal policy.

Germans worry about whether or not other members can handle the influx of cash from RRF allocations, and they also don’t want to add fuel to the fire of inflation.

Germans worry about whether or not other members can handle the influx of cash from RRF allocations, and they also don't want to add fuel to the fire of inflation.

When the fighting finally ends, however, there will be calls for increased public borrowing to help rebuild Ukraine. To quote a high-ranking French official: “At some point this year, the EU will need to put the largest amount forward for postwar reconstruction.”

Since the EU has far less credibility than the U.S. on the core substantive question of territorial and security guarantees and over Ukraine reform, which will be key for the discussion over its EU membership prospects — as last week’s summit in Kyiv showed — this is also seen as important leverage, keeping Europe relevant to the conversation, and keeping Ukraine on the agenda.

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Intriguingly, there are early indications that the Commission is planning to play a significant financial role in Ukraine’s postwar reconstruction. Recently, a secretariat was established through the G7 to advance this work, with a significant role for the Commission.

The appointment of Gert Jan Koopman, a senior Dutch official who heads the Commission’s powerful Directorate-General (DG) BUDGET, to head DG NEAR — the part of the Commission that will be responsible for managing the EU’s expansion to Ukraine — is one of two major personnel moves that has raised eyebrows in Brussels. Similarly, Koopman has been replaced as head of DG BUDGET by Stéphanie Riso, von der Leyen’s influential and highly regarded deputy head of cabinet.

These changes are significant because they were conceived by Koopman and Riso, who were both instrumental in developing the EU’s massive €750 billion NextGenerationEU initiative to aid in the recovery of EU economies following the COVID-19 pandemic.

Given Russia’s persistent attacks on Ukraine’s energy infrastructure, private estimates in Brussels place the cost of rebuilding the country after the war anywhere from €300 billion to €1.5 trillion. For this reason, Koopman’s and Riso’s efforts to raise a portion of this sum from the EU budget are intriguing.

Paris assumes Scholz will agree with the proposal of additional EU borrowing for Ukraine because he has little choice in the matter. German officials at the highest levels agree that Lindner will be less of a roadblock when it comes to the country of Ukraine.

The Stability and Growth Pact (SGP) is the European Union’s fiscal rule book, and its reform has been the subject of heated debate ever since the pandemic began. Given the pandemic, the conflict in Ukraine, and the European Union’s prior experience with the RRF, member countries are currently debating what the new rules should be in preparation for the RRF’s reinstatement next year.

The Commission formalised an approach first introduced by former Commission President Jean-Claude Juncker last year when it proposed a major overhaul of the bloc’s fiscal rules with the goal of simplifying them and moving away from largely standardised debt reduction paths to ad hoc tailored, country-specific ones, also taking into account their structural reforms.

Daniel Harrison
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