The policy response to the COVID-19 crisis has brought about significant changes in the nature and scale of EU borrowing. The outstanding EU debt increased massively, from around €40 billion in mid-2020 to €400 billion as of May 2023. This rise is expected to continue until 2026.
When large-scale EU borrowing started, interest rates were at historical lows. However, in 2022, EU borrowing costs experienced a sharp rise. On top of the widespread increase in interest rates caused by the European Central Bank (ECB) monetary tightening, the EU also faced a widening spread between its yields and those of major European issuers, which resulted from a combination of market factors, circumstantial elements and institutional features (which are discussed in detail in a forthcoming paper).
While the EU cannot control the cyclical movement of interest rates, the European Commission should continue its efforts to narrow the spread with major issuers. Further developing relevant market infrastructure and improving its issuance strategy would help. However, technical patches will not be enough: institutional developments, including progress in establishing new own resources and a long-term significant presence in the bond market, will be crucial in fully reaping the benefits of EU borrowing.
Interest costs associated with the significant portion of EU borrowing designated for financing grants will be serviced through the EU budget. Due to the current and expected high levels of interest rates, these costs could be twice as high as the initial estimates made at the beginning of the EU's 2021-2027 budget cycle. Consequently, as interest costs are accounted for under so-called ‘expenditure ceilings’ of the EU budget, this will exert additional pressure on the funding of crucial EU programmes, which are already affected by inflation. Therefore, the EU should promptly review how interest costs are accounted for in the EU budget.
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