On Tuesday, the European Commission raised € 20 billion by issuing the first EU debt securities to finance the NextGenerationEU program, the plan for Europe’s recovery from the pandemic crisis. The issue is the first in a series that should lead the Commission to raise 800 billion euros (a figure that corresponds to roughly 5 percent of European GDP) by 2026. Of these, 407 billion will be distributed to member states to non-repayable fund and another 386 billion will be made available to them in the form of a loan. Both modalities will serve to finance the national recovery and resilience plans presented by the states, of which five (those of Spain, Portugal, Luxembourg, Denmark and Greece) have already been approved by the Commission just yesterday, while the approval of the Italian one is scheduled for June 22.
This is not the first time that the European Commission has issued common debt: since last October it has raised 90 billion euros through seven issues aimed at financing the SURE program, implemented to mitigate the unemployment risks deriving from the pandemic crisis in Europe. Before that it had already issued debt securities, but the sums were negligible compared to those we are talking about now. Furthermore, yesterday’s sale marks the start of a regular debt issuance program by the Commission, which will lead it to raise an average of € 150 billion annually between now and 2026, making it one of the largest issuers of debt in euros. Of all this debt, 30 percent will be made up of green bonds, securities issued to finance projects with a positive environmental impact.
The issuance of this common European debt also has considerable political value, which is rooted in a well-known dispute between the member states regarding the so-called “Eurobonds”, proposed by the European Commission chaired by José Manuel Barroso now ten years ago. In fact, allowing the European Commission to issue debt means that all member states undertake to guarantee it: it is a step towards greater integration between the economies of the European Union, which before the pandemic many member countries, such as Germany, were decided to hinder.
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The bond placed yesterday has a duration of ten years and will pay investors an interest of 0.086 per cent per annum, paid all at maturity together with the principal. This rate is higher than that – currently negative – paid by German government bonds with the same maturity, which in this case can be used as benchmark, that is, as a touchstone, because they are those considered less risky in the Euro Area and are therefore comparable in terms of risk to a debt security issued by an institution of the size and credibility of the European Commission.
To put it bluntly, investors right now trust more to lend money to Germany than to the Commission, a much more complex institution that presents more unknowns, because it is based on the agreement between several member states, some of which do not enjoy the reputation of excellent debtors. This is why Germany can afford to apply negative rates (which is equivalent to getting paid to borrow money, a condition that seems paradoxical but is accepted by creditors who are looking for a safe place to put their money away from inflation) , while the European Commission has to pay a small interest.
Thanks to the difference in interest rates with German government bonds, yesterday’s issue was a great success: the total of orders exceeded 142 billion euros, more than seven times the total value of the securities available. There therefore appears to be an investor appetite for long-term, low-risk debt securities, despite the fact that the rates paid by these types of securities are still generally very low.
The excellent rating of the European Commission allows it to borrow money at lower rates than those that its member states (apart from Germany) have to offer investors to get into debt. And the program was designed precisely for this: with the money raised, the Commission intends to finance the member states that the markets trust least, aiming to reduce their cost of borrowing. The mechanism works in theory, as long as the Commission is able to borrow at rates lower than those of most individual states.
But the appetite for its bonds could diminish if investors begin to predict that the European Central Bank will raise interest rates. In this case, potential investors would expect issues at higher rates in the future, and therefore would wait to buy the bonds issued, forcing it to offer higher rates. This could jeopardize the functioning of the mechanism, because at that point nothing prevents member states like France, with a decent credit rating, from borrowing at lower rates and therefore refusing loans from the Commission.
It therefore seems no coincidence that ECB President Christine Lagarde reassured the market in her monthly interest rate speech at the end of May that it was “too early” to talk about a rate hike.
The Commission’s next long-term bond issues are expected in July. In total, in 2021 the Commission plans to issue long-term bonds worth € 80 billion with various maturities, ranging from 3 to 30 years. In addition to these, the issuance of short-term bonds is planned: the first should take place in September, when the Commission is expected to raise another 20 billion euros to be repaid in two years.