EU Starts Out on a Long, Costly Path to Putin-Proof Its Defense

(Bloomberg) -- The European Union is ready to get serious about fending off Russia – now it just needs to figure out how to pay for it all.

Most Read from Bloomberg

The EU’s 27 leaders this week kicked off what’s set to be months of difficult discussions over how to finance a major overhaul of its defense sector and how to dramatically step up aid to Kyiv amid heightened concerns that Russian troops are advancing in Ukraine and doubts about Washington’s commitment to Europe.

For the first time in a formal setting, the leaders discussed the possibility of issuing joint bonds to fund defense expenditures, a potentially transformative event that would herald a massive consolidation in the bloc. They also called on the European Investment Bank, the EU’s lending arm that has about $466 billion of outstanding debt, to change its remit to boost its support of the defense industry.

But most radically, the Group of Seven countries and the EU are discussing the prospect of using financial engineering to supercharge the profits from immobilized Russian sovereign assets to generate a much higher level of funding that can be sent to Ukraine. Many of these proposals, however, have already faced push-back from the bloc’s wealthier countries, including Germany and the Netherlands.

“I proposed Eurobonds and if that doesn’t fly, then propose something else, some other solution so that we can solve this problem,” Estonian Prime Minister Kaja Kallas told reporters ahead of the meeting. “Because there is a big problem of funding the defense industry. We need it now, we can’t postpone it.”

The EU is forging ahead with ambitious plans to revive the European defense industry amid increased worries that Moscow could attack Europe after its war on Ukraine and concerns about the US commitment to Europe, particularly if Donald Trump returns to the White House.

After years of pared back defense spending that atrophied the sector, more EU countries are spending at least 2% of GDP on defense as a result — an estimated nine nations last year, compared to four the year before Russia’s full-scale invasion.

German Chancellor Olaf Scholz went so far during the meeting to warn his fellow leaders that if the US withdrew from its defense relationship with Europe, then the bloc would need to do even more to meet its defense goals, according to people familiar with the conversation.

At the summit, the leaders tasked the EU’s institutional bodies to draft a report to explore all options for funding the bloc’s sector and report back by June, when the leaders will reconvene after the EU elections. On using the profits of immobilized Russian assets, leaders said they would take work forward on a recent proposal by the bloc’s foreign policy arm.

Neutral countries like Austria urged caution about using the profits from Russian assets for military purposes, instead urging the funds to be used for Ukraine’s reconstruction.

Some European nations have been reluctant to do anything that could be perceived as effectively seizing the assets, which they worry could run into legal challenges, risk the stability of the euro and face retaliation from Moscow. Meanwhile, so-called frugal countries like Germany, the Netherlands and Sweden staunchly oppose joint borrowing for what they say isn’t an immediate crisis.

Even as the leaders welcomed a Czech-led initiative to buy 800,000 rounds of ammunition for Ukraine, some of the bloc’s largest countries have yet to make concrete pledges to the plan, according to people familiar with the matter. Germany, by contrast, is spending €300 million ($325 million) to buy 180,000 shells.

Even Hungarian Prime Minister Viktor Orban, who’s previously taken stances against Kyiv’s interests, may be coming around to the scale of the problem. Orban shot back at some southern countries who wanted to avoid overly hawkish language against Russia during the summit discussions, saying the south doesn’t understand because war hasn’t reached their borders, Kallas told reporters as she cheered his comments.

But as the EU looks to boost production for everything from ammunition to air defense systems and reverse a trend of buying its key weapons systems from the US and Asia, the scale of funding needed over the coming years is likely to be much larger than anticipated. EU industry commissioner Thierry Breton has urged the bloc to consider spending €100 billion.

Some European leaders are warming up to the idea of selling bonds backed by the profits of the frozen Russian central bank assets to generate tens of billions of dollars that can be sent to Kyiv. The US proposed to its G-7 allies that they create a special purpose vehicle to issue at least $50 billion of bonds backed by the profits generated by the assets, Bloomberg reported this week.

You could use the proceeds from the Russian assets “to go to the capital markets, and use that as a yearly interest payments,” Belgian Prime Minister Alexander De Croo said on Thursday. “It’s a way of using the profits on the Russian frozen assets to leverage much bigger volume, which I think is what is necessary.”

Still the discussion over joint debt to finance defense faces an uphill battle.

Diplomats had been discussing whether to spell out the different options, including possible Eurobonds, in the text of the leaders’ conclusions, but mentioning joint borrowing was rejected by Germany, said the people, who spoke on the condition of anonymity. In the discussions, Dutch Prime Minister Mark Rutte also made clear that joint debt for defense were a red line, one of the people said.

“It would lead to a Hamilton moment,” Rutte told reporters of the joint defense bonds idea, referring to a definitive step that led to the creation of the American federal government. “That would be a very fundamental step which I don’t support. I’m for a collective of sovereign countries, not for a federation.”

Despite the limited progress on Eurobonds at the summit, the main aim for senior EU officials was to at least not close the door on the option in the future in light of push-back from the frugal nations, according to EU officials.

“The defense strategy is not viable without access to finances,” Lithuanian President Gitanas Nauseda told reporters on the sidelines. “We should have all options on the table.”

--With assistance from Ania Nussbaum, Max Ramsay, Milda Seputyte, Katharina Rosskopf, Ott Tammik, Ellen Milligan, Daniel Hornak, Jasmina Kuzmanovic, Oliver Crook, Jennifer Duggan, Ewa Krukowska, Lyubov Pronina and Kevin Whitelaw.

Most Read from Bloomberg Businessweek

©2024 Bloomberg L.P.