Before EU can borrow more, it needs a way to repay

Mario Draghi has diagnosed the EU with a grim sickness: failure to act as a community is jeopardising its ability to remain competitive.

In a recent 400 page report, the former prime minister of Italy and president of the European Central Bank also prescribes a number of antidotes ― one is for the EU to issue more bonds.

That might be music to the ears of investment bankers, and perhaps to investors too. To many others in Europe, it sounds like a jarring din.

More common debt issuance by the EU member states would have several advantages, Draghi argues: above all, raising some of the €800bn a year of extra investment he argues is needed to make the EU competitive with the US and China.

Unlocking private investment ― through the long-awaited Capital Markets Union and reforming the EU’s financial infrastructure ― is extensively covered in the report.

But, in Draghi's opinion, the private sector cannot be the driving force of a European growth renaissance. He wants public investment on an unprecedented scale, led by the EU.

Besides the money itself, Draghi declares: "It is unquestionable that the issuance of a common safe asset would make the CMU much easier to achieve and more complete."

It would facilitate the uniform pricing of corporate bonds and derivatives; supply safe collateral; create a large, liquid market that would attract international investors; give households a plain vanilla asset to invest in; and enhance the euro's role as a reserve currency.

In Draghi's view, this would go a long way to curing the inefficient financial markets, lack of “clear priorities” and absence of “joined-up policy actions” plaguing the EU.

Such an expansion of borrowing would be the next step after NextGenerationEU, the €650bn package of grants and loans for member states to recover from the Covid-19 pandemic, financed by temporary EU borrowing.

However, Draghi is putting the cart before the horse.

The elephantine EU borrowing programme, birthed in the pandemic, took it from issuing a few billion euros of bonds a year to being among Europe's very biggest borrowers at around €150bn ― a stunning and swift act of financial solidarity.

But agreeing to borrow the money in a crisis was easier than agreeing how to repay it afterwards.

The EU member states stand behind its debts, convincing the major rating agencies to score it Aaa/AAA/AA+.

But how they actually find the money to repay the bonds remains at the mercy of political wrangling.

Some 45% of the NextGenEU money was lent to member states, and they will repay it. But the other €357bn was given in grants, so the EU will have to repay the associated bonds from its 'own resources' ― its normal revenue streams.

Bruegel, the Brussels think tank, reckons the EU's annual service costs for its existing debt could reach €27bn.

To say that politics on the continent are tense is an understatement. Eurosceptic parties have been gaining votes in national and EU polls and the fiscal situation of many member states is tenuous.

For several years, the European Commission has been pressing members to agree a new settlement of own resources ― new revenues it could use for its work, including servicing its debt. To start with, it has been granted a new tax on unrecycled plastic waste.

The EC has proposed giving the EU 30% of revenue from the EU Emissions Trading System, 75% of takings from the new Carbon Border Adjustment Mechanism and 0.5% of corporate profits.

But member states have failed to agree to this package.

Most recently, the EU is preparing to increase its support for the Ukrainian war effort by €40bn. Already, there is a very public strategy under way to bypass one member state's attempt to block the joint borrowing: Hungary.

Draghi hails the EU's “large collective spending power”, but he is overstating it. When any outlays must be collectively agreed and the funds raised, and agreement is hard to come by, that power withers.

The EU needs to have a political conversation about repaying its existing debt and putting its own finances on a sustainable footing, before seriously considering borrowing a load more.

To make matters worse, the EU is trying to preach fiscal discipline to member states such as France, which have gone beyond budget deficit rules.

Issuing lots more debt of its own would only fuel the Eurosceptic parties that want to claim the EU is hypocritical and tear the whole enterprise down.

Draghi is not blind to this challenge, of course. But he has set the wheels turning on a topic for which there needs to be a precursor conversation.

Draghi's most famous intervention came during the EU sovereign debt crisis in 2012 when he committed the ECB to doing "whatever it takes" to save the euro.

That time, the ECB stepped in because politicians were shying away from doing what was needed.

There is no skirting round the politics this time. The EU and its member states are not in crisis as they were 12 years ago, but the task being urged is bigger and chronic, not acute.

Without a joint commitment to financing the EU adequately, so that it can repay its pandemic bonds, the bloc might splinter.