EU defence spending: What options Europe has to reduce dependency on US amid Russia threat

Not all EU governments support the idea, as they say special treatment for defence spending already exists in the rules. What is missing, they say, is a broader definition of what constitutes defence investment, an issue they would prefer to focus on.

Giving governments leeway to borrow more nationally may widen their deficits, however. This would raise the risk of an adverse bond market reaction in big economies already facing high deficits like France and Italy, which could wipe out the fiscal space created by the EU, Citi economists warn.

Raising spending sharply could also put a squeeze on governments' other spending needs, ratings agency S&P Global said.

Money from the EU's next long-term budget for 2028-2034

The EU will start negotiating its next seven-year budget from July. The Commission believes that it should provide funds for EU defence projects and therefore that it should be bigger than the roughly 1% of EU GNI, or 1.2 trillion euros, it is now.

Many EU governments argue, however, that while defence spending in the EU budget is worth discussing, the next budget would kick in only in 2028 and the first disbursements would be in 2030 -- far too late to start preparing for any potential invasion.

Money from the EU's 2021-2027 budget

The current seven-year EU budget, created well before the Russian invasion of Ukraine, has no proper funds designated for defence.

But around one-third of it is earmarked to equalise the standards of living between regions in the 27-nation EU, and some of that cash could potentially be used for projects that would be somehow linked to defence, like shelters for civilians or strengthening roads and bridges to allow the passage of tanks.

New joint EU borrowing modelled on recovery fund

Since 2021, the EU has been jointly borrowing hundreds of billions of euros for grants and loans to EU governments for an economic recovery after the COVID-19 pandemic.

Some officials have argued that such joint EU borrowing could be repeated for defence.

But the idea is a hard sell in Germany, where the Constitutional Court has ruled that the COVID recovery fund had to be a one-off. Some EU officials say new joint EU borrowing might be legally admissible if it did not include grants, only loans.

So far, out of 359 billion euros available in recovery fund grants only 197.5 billion has been disbursed, and of the 291 billion available in loans only 108.7 billion has been disbursed. That leaves almost 344 billion euros of unspent recovery fund money that some say could be re-directed to defence. But that would require unanimity among the EU's 27 countries, meaning an agreement is highly unlikely.

More EU issuance would be the most welcome option for investors. The boost to European cohesion could also narrow the gap between poorer and richer member states' borrowing costs.

EU bonds are popular with investors, but their appeal has been limited given new borrowing for the COVID recovery ends in 2026. Making them more permanent could increase demand and lower the EU's borrowing costs, making defence funding cheaper.

Creating a special purpose vehicle to jointly borrow and spend 

Poland, which holds the rotating EU presidency until June, has been pushing the idea of creating a special purpose vehicle that would be modelled on the euro zone's bailout fund, the European Stability Mechanism, but open to all who wish to join, also from outside the EU, like Britain or Norway.

The SPV would have paid-in capital and callable capital and borrow on the markets to lend to governments for defence projects.

However, some investors warn that setting up a brand new issuer will mean it will, at least initially, have to pay a higher borrowing cost than the EU. Some investors could also push back against buying debt from an issuer dedicated to defence.

Setting up a rearmament bank

This idea of a rearmament bank was floated in mid-January by Britian's former defence chief General Nick Carter, former European Bank for Reconstruction and Development Executive Committee member Guy de Selliers, and Senior Adviser at the Center for European Policy Analysis in Washington Edward Lucas.

Such a bank would be modelled on the EBRD, and, like the Polish SPV idea, open to countries from outside the EU to become shareholders. Under the initial idea, the bank could have 10 billion euros of paid-in capital and 90 billion in callable capital and therefore extend loans of 100 billion euros for defence projects.