Signal Berlaymont: Germany is blocking defence eurobonds, at least for now

At last week’s EU summit, German Chancellor Olaf Scholz firmly opposed issuing more EU debt to finance defence projects. 

"Do I want to accept that we issue sovereign bonds, i.e. Eurobonds, to finance armaments? My answer is no,” Scholz stated after the meeting. He also opposed refinancing national defence budgets from the EU’s financial resources. Germany’s stance, he said, was reflected in the agreed EU strategic agenda for 2024-2029.

The EU should focus instead, he said, on developing existing research and industrial funding schemes. “Do I want better cooperation among us on defence? Yes of course, in NATO, and also with the industrial funding, research funding provided by the European Union. There are concrete projects being funded here, special joint weapons systems, and the further development of these systems.”

Still, Germany failed to include a statement in the strategic agenda saying defence policy was a national matter, as Scholz attested. Instead, he was forced into naming the European Investment Bank as a possible financing source for “joint” EU defence procurement. The EIB is sitting on a huge pile of cash. Clearly, the recent corruption probe into its former head Werner Hoyer, or the fact that it has been named as one of the most least transparent international institutions, did not stop EU leaders from eyeing it.

Outgoing Dutch PM Mark Rutte backed Germany in opposing a new round of joint EU borrowing. In 2020, Rutte already gave in to a massive round of joint EU borrowing for “Covid recovery” spending for the EU’s €800 billion “next generation” scheme. This scheme is now mired in scandals around misuse of these funds, which EU countries still need to pay back. Perhaps Rutte wasn’t keen to doing even more damage to his legacy.

Rutte’s stance angered some EU leaders, like Polish PM Donald Tusk, who recalled after that "everybody, almost everybody, loudly reminded Mark Rutte that he will soon take up the role of NATO secretary general, and that he should be doing everything to make sure that Europe spares no money or resources.” “It was a bit awkward," Tusk added, "I saw a blush on his face after everyone pointed out to him: 'Wait a minute, man, you should be mobilising everyone to spend more, not less, on defence'.”

A delicate topic

Poland is spending almost 4 per cent of its GDP on defence, while Rutte’s country may only this year finally meet NATO’s defence spending target. 

So Tusk is understandably frustrated, but it is unlikely “everybody” really sided with Poland here. For a start, the Nordics firmly oppose defence Eurobonds, while a number of EU member states – Ireland, Austria, Malta and Cyprus – are not NATO members. Eurosceptic Hungary and Slovakia may also not be so keen. 

The issue is so toxic Commission President Ursula von der Leyen opted to just give an oral update about it at the summit, while avoiding putting “joint defence bonds” in writing.  

It was France that came up with a concrete plan for defence eurobonds earlier this year. The big question is whether its changing political situation will also have altered France's views. Surprising reports said French President Emmanuel Macron supported Scholz’s attempt to include a statement in the strategic agenda that national defence was a completely national matter.

According to European Commission President von der Leyen – who may just have secured a second term, provided she can muster a European Parliament majority in an upcoming secret vote in two weeks – the EU requires €500 billion in defence investments over the next decade. She referred to both EU defence projects and national armed forces. So it was not clear whether how much of that sum was to continue providing weapons to Ukraine, and how much was money to modernise European defence.

Pro and Contra 

In a paper advocating defence Eurobonds, Peterson Institute’s Jacob Funk Kirkegaard argues in favour of Ukraine's strongest EU supporters “agreeing to such funding for Ukraine through European defence bonds makes national economic sense, as it spreads the cost of providing necessary European assistance to all EU members evenly.”

Another financing mechanism is to use frozen Russian assets in some way or another. Despite US pressure, European countries oppose seizing those assets outright, because the European Central Bank has cautioned this may undermine the euro. The body has warned that such a move would signal that assets denominated in euros might not be safe.

An agreed upon compromise, originally floated by Belgium at the G7, is to use these assets to generate a securitised stream of future income to underwrite a possible $50 billion upfront loan to Ukraine. But Euroclear, the Belgium-based institution acting as custodian for the Russian assets, warned: “Using assets that don’t belong to you as collateral is pretty close to an indirect seizing or a commitment to future seizing, which could have exactly the same effects on the markets as a direct seizing.”

Especially if US President Trump returns to power, such approaches may become trickier if the United States removes its support for Ukraine. If European countries continue supporting Ukraine, there will be a renewed debate on defence Eurobonds.

The main argument for EU member states jointly issuing debt is it would be cheaper. This is a questionable assumption. Only a few days after the EU election, indexer MSCI Inc. decided not to include the EU’s outstanding bonds in its sovereign gauges. As a result, investors' appetite for EU debt dropped. EU debt now trades weaker than French and German debt.

There is a more fundamental problem, even for countries currently spending vast amounts on helping Ukraine, like Poland, Finland, or the Baltics, and who may well turn out to become net beneficiaries from defence Eurobonds. This is the issue of democracy. It gives the bureaucracy issuing the debt, the European Commission – or the European Stability Mechanism (ESM), as the Peterson Institute suggests, in case of a Hungarian veto – leverage over how the money will be spent. At least, that is what we currently witness with the EU’s Covid recovery fund, where the EU Commission tells EU member states the conditions under which they can receive cash they will need to pay back in the future.

In that context, it is also useful to remember the EU’s questionable track record on foreign policy.  These span rather amusing episodes like sofagate to the EU’s gaffe-prone “foreign policy chief” Borrell's “humiliation” by Russian Foreign Minister Sergey Lavrov. Even just allowing the EU to engage in joint defence procurement may be a bad idea. Recently, it emerged the Chinese military has tapped into EU-funded research. Over the past decade, the EU financed at least 14 projects with Chinese universities deemed "high-risk" by experts.

Last but not least, there is the issue of moral hazard. Defence spending laggards like Belgium, the Netherlands, and Germany may cut their already tiny national defence efforts once there is EU cash coming their way – even if they would be net payers into that scheme. For that reason, the Peterson Institute suggests, “it would be best to limit European defence bonds to the direct military support for Ukraine, at least initially.”

These last words give away the type of dangerous slippery slope joint defence bonds could become. Outgoing NATO secretary general Jens Stoltenberg has been critical about these EU defence initiatives, warning “the EU cannot defend Europe” “We should have absolutely no confusion about the fact that NATO has to be and is the bedrock, a kind of defining framework for the defence of Europe,” he observes. EU leaders had better listen carefully.