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Blog post

An ambitious plan without adequate financing?

HOW TO ADDRESS THE UNDERFUNDING RISKS FOR THE REPOWEREU PROPOSAL

| 15/06/2022

| Andreas EISL |

| Economics and finance

Download pdf → | ← Download epub

--------------------------------------------------------------------------------

Recommended citation:
Eisl A. 2022. “An ambitious plan without adequate financing?“, Blogpost, Paris:
Jacques Delors Institute, 15th June.

--------------------------------------------------------------------------------

This blogpost focuses on the financing dimension of the European Commission’s
recent REPowerEU proposal. It highlights that the current plan risks to remain
seriously underfunded due to insufficient and unsuitable funding sources. The
financing of REPowerEU needs to be fundamentally rethought to ensure that the
2022 Russian invasion of Ukraine accelerates rather than slows down the EU’s
climate ambitions. To this end, this blogpost makes two proposals: a modest one
aiming to make the RRF loans more attractive to Member States and an ambitious
one based on transforming unused RRF loans into grants.

1. CONTEXT

Just on its tracks to leave the economic fallout of the Covid-19 pandemic
behind, the Russian invasion of Ukraine weighs heavily on Europe’s economic
recovery. The war painfully exposes the EU’s dependence on Russian fossil fuels.
It also exacerbates inflation pressures due to increasing energy prices and
supply chain disruptions that accompany the global rebound from the pandemic.
Subsequently, the economic growth outlook for 2022 and 2023 has lowered
significantly. To attenuate price hikes for citizens, EU Member States have
drawn up costly budgetary responses at the national level. Many of the measures,
however, also extensively subsidise fossil fuels, money that would be urgently
needed to phase-out fossil fuels and address the climate crisis instead.

2. THE REPOWEREU PROPOSAL

Investment needs

To reduce Europe’s dependence from Russian fossil fuels and to accelerate the
green transition, the Commission announced its REPowerEU proposal on May 18. To
achieve these goals, it states that additional investments amounting to €210bn
are necessary between 2022 and 2027, and €300bn to cover the whole period until
2030. The expenditure areas are detailed in an accompanying staff working
document. The largest identified investment needs are €113bn for renewables (PV,
wind and hydrogen), €56bn for energy efficiency and heat pumps, €41bn for
adapting industry, €39bn for the power grid and storage and €37bn for increased
biomethane production. To adapt the existing infrastructure to the phase-out of
Russian fossil fuel imports, the plan equally envisages to spend €10bn on new
LNG infrastructure and pipeline corridors and €2bn each for the coal and oil
sectors.

Financing sources

While REPowerEU details investment needs by sectors, the financing sources of
the plan remain considerably more vague, provided in a simple factsheet. NGEU’s
Recovery and Resilience Facility (RRF) is supposed to provide the bulk of the
financing for REPowerEU, drawing on the Facility’s currently unused loans,
amounting to €225bn. In addition, the plan intends to generate €20bn in new
grants through the auctioning of Emission Trading System (ETS) allowances from
the existing Market Stability Reserve and to allow the transfer of funds from
cohesion policy (up to €26.9bn) and the Common Agriculture Policy (up to €7.5bn
from the EAFRD) into the RRF.

Beyond these European financing sources, the Commission considers additional
funding for the REPowerEU plan to come from the European Investment Bank,
national funding and private investment. The current proposal, however, does not
specify the size and type of financing that should be provided by these
stakeholders.

As the Commission and Member States consider the RRF’s national recovery and
resilience plans (NRRPs) a success model so far, modified NRRPs are supposed to
become the central instrument through which the required funds should be
channelled for evaluation and implementation. To allow for climate-harming
investments in oil and gas currently forbidden in the RRF Regulation, but deemed
necessary for more energy security, the proposal envisages a softening of
several existing criteria, such as the ‘do no significant harm’ principle.

3. REPOWEREU FINANCING CHALLENGES AND SHORTCOMINGS

The current REPowerEU proposal entails serious underfunding risks for the twin
priorities of reducing the dependence on Russian fossil fuels and accelerating
the green transition. If the EU really wants to build on the success model of
the RRF, it needs to revive its logic: providing a legitimate balance between
solidarity and responsibility mechanisms between Member States by linking
European grants with national investments and reforms. At the national level,
the provision of grants made it significantly easier to justify the acceptance
of conditionality. The grant component of the RRF equally ensured that all of
that money is actually spent by the Member States, increasing public investment
across Europe.

But under the current REPowerEU plan, the grant component is smoke and mirrors.
Additional investment needs cannot be met by simply shuffling money around. The
transfer of cohesion policy and CAP funds only moves European funding between
different spending and control mechanisms. Similarly, the use of the market
stability reserve to create additional revenues might, in the end, only transfer
resources from national budgets and EU ETS Funds (Innovation Fund, Modernisation
Fund) to the RRF, as the selling of additional ETS allowances has a negative
impact on the carbon price and thus on national and EU revenues linked to the
ETS. Depending on the size of carbon price reduction, additional revenues linked
to the market stability reserve could actually be cancelled out by revenue
losses for Member States and the EU ETS Funds. To make things worse, the
auctioning of additional ETS allowances would also allow for more CO2 emissions
in the short term, going at odds with European climate ambitions.

A significant amount of ‘fresh’ money for financing REPowerEU can thus only
come from the unused loan component of the RRF, but there are several reasons
why many Member States have not made use of their share so far. First, the RRF
loans can be attributed to individual countries and subsequently add to national
public debt, falling under the – currently suspended – fiscal rules of the
Stability and Growth Pact. Member States with high public debt burdens and
little fiscal space could thus be hesitant to further constrain their already
limited fiscal room of manoeuvre in the future. Second, other countries might be
unwilling to accept RRF loans because they come with conditionality. If a
country can indebt itself with similar – or even with slightly higher – bond
interest rates in the markets in comparison to the rates offered by the
Facility, policy-makers will prefer to retain complete spending control. This
creates an underfunding risk for the REPowerEU spending objectives.

4. WHAT IS NEEDED TO ADEQUATELY FUND REPOWEREU – GENUINELY NEW RRF GRANTS

The key element to repeat the perceived success of the RRF would be to once more
link European grants with national investments and reforms. For this to work,
truly additional revenues need to be made available. Neither the proposed use of
the ETS Market Stability Reserve, nor the transfer of funds from cohesion policy
and CAP can fulfil this function.

An ambitious option would be to transform at least part of the unused €225bn of
RRF loans into grants. It is difficult to decide the exact size of additional
grants on a purely technical basis but at least 50% of remaining loans turned
into grants would surely provide a very strong incentive for Member States and
send a strong political signal. As the final size of NGEU was to a significant
extent based on political rather than macroeconomic considerations, we could
actually draw on the central political proposal paving the way for NGEU. In May
2020, Germany and France proposed €500bn in grants through common EU borrowing
for a European recovery fund. During the NGEU negotiations, this was changed
into €390bn in grants and €360bn in loans. With the transformation of €110bn of
the remaining RRF loans into grants, we could come back to the grant size of the
initial Franco-German proposal. Transforming at least a part of the RRF loans
into grants would allow to provide additional European grants without having to
resort to a second common borrowing instrument, or to reopen the overall NGEU
debt envelope.

Unfortunately, Art. 5 of the 2020 Own Resources Decision (ORD) specifies the
share of grants and loans, meaning that an increase of the grant component in
the RRF would require unanimity plus the ratification of an amended ORD in all
27 EU Member States, in addition to changes to the European Recovery Instrument
(EURI) regulation and the RRF regulation. There would, however, be no need to
modify Art. 6 of the ORD, as the temporary increase of the own resources ceiling
to cover the liabilities of NGEU common borrowing includes the full amount of
€750bn already.

While politically difficult, this approach would also allow to address a number
of other relevant issues. First, an amendment of the ORD, EURI and RRF
regulations would allow to better articulate the solidarity mechanism to respond
to the 2022 Russian invasion of Ukraine and its consequences, instead of relying
on the solidarity logic underlying the common response to the Covid-19 pandemic.
Second, the explicit adaptation of parts of NGEU to deal with energy dependence
and the related need to accelerate the green transition should equally imply the
development of a new contribution key of the remaining loans transformed into
grants. The war has asymmetric effects on EU Member States, but with a different
distribution from the Covid-19 pandemic. An amendment of the RRF regulation
should take this into account, reallocating grants particularly towards those
countries that are very dependent on Russian fossil fuel imports and that have
shouldered a large part of the influx of Ukrainian refugees. In addition, a new
contribution key could take into account in which countries investment in
renewable energy projects would make most sense. Finally, changes to NGEU could
also address a few broader problems that might hamper its implementation. For
example, some of the deadlines linked to the NGEU budgetary guarantee for
InvestEU might be too short to allow even for a partial execution of the
programme. A deadline extension in Art. 3 (6) of the EURI regulation would help
to avoid losing crucial financial support for accelerating the green transition.

5. AN ALTERNATIVE APPROACH TO REDUCE UNDERFUNDING RISKS – MAKE RRF LOANS MORE
ATTRACTIVE

Should Member States not be able to agree on a new grant component for the
REPowerEU plan, a more modest and clearly second-best solution to reduce the
underfunding risks would be to make the unused RRF loans more attractive for
Member States. Three changes could help to alleviate at least some of the
material and institutional constraints on Member States’ budgets. Some of them
could also complement the RRF grant approach discussed above.

First, the loan agreements for the remaining unused RRF loans should allow for
more favourable repayment conditions than currently available to Member States.
A front-loading of investments to achieve the REPowerEU objectives should thus
be linked to a back-loading of the repayment of loans. As illustrated by the
existing Portuguese RRF loan agreement, RRF loans come so far with a 30-year
maturity, including at 10 year grace period with the subsequent repayment of the
principal over the course of the following 20 years. To make the remaining RRF
loans more attractive, the loan maturities and the grace period could be further
prolonged. In addition, the repayment of the principal could be concentrated
towards the end of the NGEU repayment deadline in 2058. Such loan
characteristics should especially be considered for those Member States that
currently have a high public debt burden (such as Italy and Greece), reducing
immediate fiscal consolidation constraints beyond the fiscal rules themselves.
Backloading loan repayment towards the 2040s and 2050s would provide some more
fiscal space for Member States in the 2030s. While the ORD specifies that debt
repayment “shall be scheduled (…) as to ensure the steady and predictable
reduction of liabilities”, this should not exclude the possibility to back-load
loan repayment to a certain extent.

Second, the remaining unused RRF loans should be excluded from the common fiscal
rules. The renewed suspension of the European fiscal rules until the end of
2023 provides sufficient time to include such an exemption in the ongoing reform
process of the Stability and Growth Pact. Especially for countries that already
have a very limited fiscal room for manoeuvre, this would reduce immediate
fiscal consolidation constraints and make the use of the remaining loans more
attractive.

Third, some Member States have already exhausted their share of the RRF loan
component (Italy, Romania, Greece) or at least used a part of their original
share. While the current RRF regulation already allows for a reshuffling of
unused loans “in exceptional circumstances” – a point which is reinforced in the
proposed amendment of the RRF regulation – the remaining unused RRF loans should
be reallocated from scratch among all 27 EU Member States. This could be done in
two ways. The loans could be either allocated according to each country’s GDP
(the approach chosen so far for the loan component) or according to the national
investment needs to achieve the REPowerEU objectives. Such a reallocation of the
loan component between countries would only require a modification of the RRF
regulation, but not of the EURI regulation or the ORD.

CONCLUSION

There are no short-cuts to adequately finance the current REPowerEU proposal. To
avoid underfunding risks for the ambitious plan to reduce Russian fossil fuel
dependence and accelerate the green transition, truly additional money needs to
be put on the table. This blogpost has laid out two possible – and partly
complementary – avenues that could reduce fiscal policy and rule constraints and
incentivise EU Member States to achieve the objectives set out by the
Commission. The provision of additional grants would surely be the best solution
but would demand to overcome significant political hurdles. In the absence of an
agreement on grants, the backloading of loan repayment and an exclusion of
remaining unused RRF loans from fiscal rule requirements could also help to
reduce underfunding risks for REPowerEU. Political leadership to ensure adequate
funding is needed in this situation, where a hesitant approach will only lead to
higher budgetary costs in the medium- and long-term.

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