Moody's raises outlook on European Union to Stable from Negative; Affirms AAA - update
RATIONALE FOR THE AFFIRMATION
- The first driver of the affirmation is the joint and several liability of member states to their EU obligations. In the event that a borrowing member state fails to repay a loan on time and the EU's own resources are insufficient to service the debt, the EC has the right to draw on all member states in order to make up for the shortfall -- Article 323 of the Treaty on the functioning of the EU legally obliges member states to provide funds to meet all of the EU's obligations in respect of third parties. Moreover, if the EU needs to call for additional resources from member states beyond the contributions outlined in the annual budget, the amount it calls from each member does not have to be proportional to that member's contribution to the EU budget. In this context, the strong support for the EU evident among the member states is critical to its rating.
- The second driver is the EU's multi-layer debt-service protection given: (1) the borrowing country's commitment to repay its loan (the funds raised are lent back to back, and the borrowing country pays down the interest and loan principal); (2) the EU's vast budgetary resources relative to its debt obligations; and (3) the European Commission's right to call for additional resources from member states, if needed.
- The third driver of the affirmation is the EU's conservative budget management. The European Commission (EC) is responsible for EU budget drafting and implementation, subject to approval by the Council and the European Parliament (EP). The EU Treaty requires the EU to balance its budget, prohibiting any borrowing to cover budgetary shortfalls. In addition, the EU's Multiannual Financial Framework (MFF) provides the general framework for a seven-year period and establishes a ceiling for total expenditures for the annual budgets during that period. All borrowings by the EC are ultimately guaranteed by the EU, either through its budget or in the form of the EC's right to draw on all member states to cover any shortfalls. In this context, the EU may defer budget expenditures to accommodate its debt service.
-- WHAT COULD CHANGE THE EU'S RATING - DOWN
- Risks to the creditworthiness of the EU and to its rating include a deterioration in the creditworthiness of the EU member states, as reflected in downgrades of Moody's ratings for these states. The EU's rating is particularly sensitive to changes in the ratings of the four countries rated Aaa or Aa1 that make large contributions to the EU budget (i.e., Germany, France, the UK and the Netherlands). A weakening of the commitment of the member states to the EU and changes to the EU's fiscal framework that would lead to less conservative budget management would also be credit negative.