During a significant EU summit in Brussels on March 6, leaders from the 26 member states agreed to allocate approximately €800 billion ($867 billion) for what they referred to as essential for the “rearmament of Europe.” European Commission President Ursula von der Leyen has been entrusted with the task of quickly determining how member states can be supported in financing their contributions to this initiative.
Currently, it seems that EU nations are capable of covering around €650 billion of the €800 billion package through their own sovereign debt issuance, instead of relying on collective EU borrowing.
The remaining €150 billion is anticipated to be loan assistance secured by the EU budget, bringing the bloc closer to the concept of shared debt.
Unlimited Debt
In Germany, the chancellor-in-waiting Friedrich Merz has already abandoned his campaign slogan against new debt and is now promoting unrestricted borrowing to support national defense efforts, coining the new phrase “whatever it takes,” as he recently stated.
To encourage other EU nations to adopt a similar stance, von der Leyen intends to activate what she refers to as an “escape clause.”
“This will allow member states to significantly enhance their defense spending,” she remarked at the Munich Security Conference in February.
Jürgen Matthes, who leads the research unit on International Economics and Economic Outlook at the Cologne-based Institute for Economic Research (IW), believes von der Leyen’s escape clause might assist EU member states in aligning their defense spending with the Stability and Growth Pact of the bloc.
In effect since 1998, the pact sets a public debt ceiling of 60% of GDP and a budget deficit cap of 3% for the 20 countries that currently use the euro. Initially intended to curb excessive national borrowing, numerous eurozone nations have repeatedly violated this principle.
If these nations need to incur additional debt to cover their military expenses, Brussels will likely overlook those breaches instead of enforcing penalties, as has been the case previously.
Interest Rate Spreads as a Warning Signal
Inside the EU, a more lenient implementation may provide governments with greater fiscal flexibility, but whether this will be convincing to financial markets is uncertain. Investors primarily assess a country’s creditworthiness, reflected in ratings from specialized agencies. A poor rating increases borrowing costs.
Among eurozone nations, Germany benefits from the lowest interest rates on its debt. The difference between German rates and those of other countries is known as the “spread.” For instance, Italy must incur a so-called risk premium of 1.2 percentage points compared to Germany, leading to higher debt costs.
At the onset of the EU sovereign debt crisis in 2010, the spread was much narrower but soon escalated to nearly five percentage points. Portugal and Greece faced even steeper premiums.
The greater the interest rate, the less fiscal flexibility a country has for other priorities, such as investment, education, or pensions. These disparities nearly pushed the eurozone to collapse during the debt crisis.
The impact of new defense-related debt on spreads is “not yet clear,” Matthes told DW. He doesn’t dismiss the risk of certain eurozone countries accumulating more debt than they can manage under rearmament initiatives.
Is it Time for Eurobonds?
Large expenditures inherently carry large risks — is this the right moment for joint borrowing via Eurobonds?
The concept is straightforward: If European nations collectively incur debt, the borrowing terms would generally be more favorable for most than if they each opted for individual debt issuance. They would also benefit from the strong credit ratings of wealthier member states. However, affluent countries like Germany would then be responsible for the total debt raised through joint EU borrowing.
This issue has long divided the EU, largely along a north-south axis. Northern nations — including Germany, Austria, the Netherlands, and Finland — accuse southern countries like France, Italy, Spain, Portugal, and Greece of fiscal irresponsibility and have resisted supporting their debt.
EU law also prohibits one country from assuming another’s debt. Article 125 of the Treaty on the Functioning of the European Union explicitly imposes this restriction.
Utilizing Eurobonds for defense financing would require an amendment to EU treaties. Such a change is not only time-consuming but would also necessitate unanimous approval, casting doubt on its practicability.
Nevertheless, the EU has previously ventured into collective borrowing, albeit with limited liability.
For instance, the €750 billion recovery fund launched during the COVID-19 pandemic in 2021 represented the first occasion the EU took on collective debt. In that case, liability was limited to each country’s share of the EU budget — meaning Germany was accountable for about a quarter of the total amount.
Similarly, the European Stability Mechanism (ESM) and its predecessor, the European Financial Stability Facility (EFSF) — both bailout funds aimed at assisting struggling eurozone nations during the 2010 sovereign debt crisis — represented forms of joint debt.
Necessary, Unlikely, or Practical?
“Whether joint borrowing will prove necessary remains to be seen,” noted Matthes from the IW.
Clemens Fuest, president of the Munich-based ifo Institute, considers it “highly improbable” that defense expenditure will be financed through shared debt.
“This tool isn’t suitable as defense expenditures are national expenses, and the EU would first need to establish a defense policy framework. However, urgency is the current priority,” Fuest conveyed to DW via email.
Conversely, Jens Boysen-Hogrefe from the Kiel Institute for the World Economy (IfW) views joint debt as “practical” for funding shared military initiatives. During an interview with DW, he queried, however, whether “all EU nations will meet their commitments to collective defense in the coming years.”
Boysen-Hogrefe also believes that joint borrowing for Europe’s defense should involve non-EU nations such as Britain and Norway to ensure that decisions are not hampered by the EU’s principle of unanimity. This would avert situations where countries like Hungary could use a veto to obstruct progress. Furthermore, the European Investment Bank (EIB), which is co-owned by EU member states, could play a “crucial role,” he surmised.
For the time being, the specifics of how Europe will finance its rearmament remain uncertain — as does whether Friedrich Merz will reassess his staunch opposition to joint debt.
Last September, Merz stated he would “do everything in my power” to prevent the EU from “entering such a debt spiral.” He has not yet replied to DW’s inquiry about any changes to his position.
This article was originally written in German.
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