The numbers behind a new EU Growth Fund

The European strategy for Greece took a new twist in the summer of 2011, as economic growth was included in the policy agenda. The rationale is self-evident. A severe macroeconomic adjustment like the one Greece has committed to is self-defeating if economic growth remains weak or is indeed further weakened by the huge fiscal consolidation effort.

Different strategies may be used to support growth including non-monetary measures that aim to reform a country’s legal and regulatory framework. Yet, it is difficult to imagine that these forms of intervention are sufficient in a country that is clearly stacked in a recession. Instead, fresh financial resources may be needed. They could also help overcoming socio-political resistance to regulatory measures.

Greece still has €15bn available from its own Structural and Cohesion funds out of the €20.4bn that were allocated at the beginning of the multi-annual financial framework (MFF) 2007-2013. In the July 2011 European Council, the EU committed to supporting Greek authorities in the take-up of these funds. Official documents referred to a Marshall Plan for Greece and a Taskforce was created with the assignment, amongst many others, of supporting national authorities in the selection and implementation of the most worthy investment projects so as to guarantee more rapid and efficient absorption of outstanding EU funds.

The operation and the numbers of the EU Budget are not always easy to grasp. Let us explain how structural funds will be channelled to Greece, according to the current plan.

Structural and Cohesion funds are normally paid to the member states only once a project has been concluded. They never finance 100% of the total costs and require national authorities to co-finance them. The national co-financing rate varies depending on the wealth of the beneficiary and the type of project. Before the debt crisis, the average Greek co-financing rate was 22%. In summer 2011, it was brought down to 15% and legislation initiated to further reduce it to 5% in 2012.

The Taskforce for Greece is deeply involved in helping authorities choose the projects that would yield the highest possible return. Project selection is now a pivotal exercise considering that, following the reduction in the national contribution, the total value of outstanding EU-supported projects has decreased from €18.3bn (15+15*0.22) in 2010 to €17.25bn (15+15*0.15) when the national co-financing was cut the first time and down to €15.75bn (15+15*0.05) under the current co-financing rules.

Whilst the EU distributes funds just after project completion, it has nonetheless a track record of facilitating the kick-off of projects by offering advance payments in the first three years of each MFF. Pre-financing is equal to a share of the total initial allocation for cohesion of between 7.5% to 11% depending on whether the recipient is an old or a new member state. As of end 2009, Greece had already received its 7.5%-share in advance payments for about €1.5bn.

Following the European Council of July 2011, the European Commission has committed to supporting growth in Greece through additional pre-financing. The initial offer was €1bn which is close to the difference between the old and the new national contribution after the first cut in the co-financing rate and is now €1.5bn following the second cut. An additional €500m from outstanding Structural funds is to be channelled to the Greek economy through the national banking system. This is a programme known as Jeremie has the purpose of distributing EU funds to initiate small investment projects rather than refunding completed ones. In turn, a total sum of €2bn is going to be combined with funding from the European Investment Bank (EIB) to bring it up to €6bn.

Will the cash be sufficient to boost economic growth in Greece? The selection of the worthy projects is a crucial operation as is their delivery. The Taskforce shall offer an important support in project selection. But why not giving more? There won’t be a more pertinent time for Greece to make use of its own €15bn.

There is an evident constraint on the capacity to advance Structural funds to Greece in larger amounts than the envisaged €2bn. As a matter of fact, payments are agreed and executed annually in the framework of the EU Budget. If a net beneficiary from the EU cohesion policy like Greece receives EU funds in any given year, this cash is materially paid in by the EU net contributors. The agreed €2bn is what the EU is probably able to collect from the other EU member states in 2012 and EIB support an expedient for augmenting short-term the size of resources pumped into the Greek economy.

Still, there may be a potentially more powerful leverage. Of the financial assistance instruments that were created in the midst of the crisis, the only one that follows the Community Method and is thus immune to member states’ veto is the European Financial Stabilization Mechanism (EFSM). It is used in support of euro zone countries in difficulty and works just like the Balance of Payment facility for non euro zone countries, whereby the European Commission borrows on markets under implicit EU Budget guarantee with AAA rating at an average interest rate for the beneficiary of 4.5%.

The size of the EFSM is set at €60bn, an amount close to the margin available under the own resources’ ceiling (ie the difference between commitments and payments to the EU Budget) and Council Regulation (EU) No 407/2010 of 11 May 2010 imposed it does not exceed that margin. Most of it has been used for Ireland (€22.5bn) and Portugal (€26bn) but there is still about €12bn outstanding.

One thing is to borrow on markets to cover for a government’s refinancing needs; another is to borrow to support investment projects. The latter are less risky and need less guarantees. As the European Stabilization Mechanism (ESM) - the permanent fund for crisis management and resolution becomes operational, the EFSM may be transformed into a proper and permanent EU Growth Fund in support of assisted countries.

Let us explain how it would work.

A country that falls under programme and receives funding from the ESM and possibly the European Financial Stabilization Fund (EFSF) - if that remains active, will also apply for the “EFSM-Growth Fund”. The European Commission shall then borrow on markets up to the value of the country’s outstanding EU funds (for Greece €15bn). There is no risk, as that money is truly transferred to the programme countries even if in smaller amounts every year over the MFF (the current one runs until 2015). Thus, capital is 100% guaranteed.

On the other hand, the EU advance payments (for Greece €2bn) may be collected in a Guarantee Fund that acts as a “liquidity cushion” in case of late payment on capital and accrued interests. This would avoid calling on the EU Budget every time there is a delay. It would work just like the already existing External Guarantee Fund, which covers external actions guaranteed by the EU Budget (Euratom, macro-financial assistance, EIB external financing). The existing External Guarantee Fund has a target value of 9% of the outstanding loans. If the same system is applied to the new EU Growth Fund, the €2bn now promised to Greece are indeed the amount needed as a cushion for borrowing €15bn on the market.

It is worth taking the chance.