I With 27 member states and usually 4 or 5y mandates, the EU on average will have 6-7 elections/year, so roughly one election every couple of months. Last week of relevance, too, for European politics, EU candidate Moldova saw a victory for the incumbent pro-EU government of prime minister Maia Sandu, despite heavy Russian attempts at election interference in favor of the pro-Russian opposition. This weekend, EU member Czechia goes to the polls, in an election that could usher in a period of political and economic instability in the country, though create only minor additional problems for EU cohesion vs. Russia.
All polls suggests that the election will to a large extent be a “kick the bums out election”, as concerns over rising cost of living have undermined public support for the centrist government of prime minister Petr Fiala, and put former prime minister and on-off populist and billionaire Andrej Babis in pole position to win. At the same time, however, with 26 parties on the ballot (including some very colorful ones promoting cars over bicycle lanes) and a possible 8-10 parties clearing the 5 percent support threshold for parliamentary entry, there is virtually no chance that Babis would not have to find one or several coalition partners.
The government formation process will take time, and the main political question in Prague is whether Babis will be able to rely solely on the support of far-right nationalist parties when forming a government, and if so whether he would choose to take this political path? Or if Babis will instead have to rely on more centrist parties to gain a parliamentary majority. Should Babis’ ANO Party disappoint at the polls, there is also a small possibility that another centrist coalition might be cobbled together. The base case though must be that the Czechia’s next prime minister is again Andrej Babis, and that this change will see the country adopt a less pro-Ukrainian position (Babis has for instance called for the end to the Czech-led initiative to purchase artillery ammunition for Ukraine around the world to be transferred to NATO, though this might not affect actual artillery shell deliveries to Kyiv, as these increasingly come from Europe’s own expanding production capacity), possibly closer to that of other central European countries in Slovakia and Hungary.
At the same time, however, there are important constraints on Babis’ ability to potentially take Czechia in a fundamentally different economic and political direction, even if he is able and chooses to rely on far-right support to form a government. Babis is personally affected by an ongoing corruption case, related to his agricultural industrial conglomerate, and Czechia has strong laws aimed at preventing conflicts of interests among officials and their private businesses. Consequently, Czech President – and strong Ukraine supporter – Petr Pavel could in principle refuse to appoint Babis as the next prime minister, even if his party won the election, triggering a possible political if not constitutional crisis in Prague. Pavel is though highly unlikely to do so, as it would go against the expressed political will of Czech voters, and he may instead seek to influence the composition of any new Babis-led government. Pavel is also certain to act against any attempt by a Babis-led government to undermine Czech commitments to either the EU or NATO.
There are in other words important guard rails in place in Czech politics, and investors should not assume that a return of Babis to power in Prague will fundamentally alter the EU’s position on Ukraine, especially as the EU is in any case (see next section) likely to decide on a new multiyear funding program for Kyiv before Babis takes power. Rather, the main concerns of Babis will be domestic and fiscal, where one reason for the unpopularity of the current government is the budget consolidation it has implemented in recent years, as the primary deficit of the general government was reduced from 4-5 percent of GDP during Covid-19 to less than 1 percent by 2024. A Babis-led government may reverse course and boost fiscal spending to try to implement a long list of campaign promises.
In sum, the Czech elections will – appropriately – be a matter mostly for investors in Czech assets, and not have major spillovers on broader EU policy positions in Ukraine or elsewhere.
II At the informal EU Council in Copenhagen this week, political discussions among EU leaders were held on among other things the proposal for an “EU Reparations Loan” to Ukraine, linked to the immobilized Russian assets held in European financial institutions in especially Belgium. There is by design never any real deliverable or concrete outcome of informal EU Council meetings, so observers should not – despite press headlines in for instance the Financial Times implying this – be disappointed by the lack of concrete decisions this week. In fact, important political progress was made in Copenhagen and it should now be the very strong base case for investors that the EU, likely by the next regular EU Council in late October and at the very latest by the year-end EU Council in December, will decide to provide Ukraine with adequate multi-year financing to sustain its war efforts for at least the duration of the existing IMF program running until 2027.
The legal details regarding the set-up of the Reparations Loan remain a work in progress, but essentially relevant EU members – e.g. the big ones and the wealthy ones – came around in Copenhagen to the political realization that this is another “TINA situation” for the EU. There Is No Alternative, as reflected in the lack of any competing policy proposal for how the EU can continue to finance Ukraine’s defense of itself and the rest of Europe against Russian aggression. The EU will, regardless of the final legal format chosen, de facto assume the risk of lending Ukraine up to maybe $150bn in 2026-2027, as Ukraine would only be obligated to repay the loan once Russia pays it war reparations. Moscow is highly unlikely to do so, and in fact the only plausible reason for it to do so would be for it to, at some point after the war has ended, get the EU to lift economic sanctions against Russia. Importantly, therefore a direct political link between a reparations loan and Russian underlying assets will be established that will see European sanctions in Russia remain in place likely long after the fighting in Ukraine has ended.
There are still details to be agreed and a process to go through. The Belgian government continues to hold out for firmer and clearer legal guarantees against any possible financial fallout from the link to assets with EuroClear in Belgium, the ECB continues to be very keen on other G7 members (whose reserve currencies they see as competitors to the euro) joining any action the EU might take, and a furious debate will have to be had between the EU, IMF and the Ukrainian government about just how much money Ukraine will need in 2026 and 2027, and precisely what this money can be used for. Kyiv will obviously want as much money as possible, and as much freedom to spend it as possible, while the IMF will want to ensure at least a “fig leaf of credibility” for its forward looking Ukrainian economic forecast. And different EU members may want to see Ukraine buy ever more European (rather than US) made weapons for the war effort, in turn supporting European efforts of building up their own defense industrial sectors. And a way around a likely Hungarian veto will also have to be found, and surely EU leaders will want to ensure that funds lent to Ukraine goes towards the war effort, rather than say repaying existing Ukrainian private bondholders.
Yet, none of these concerns are likely to be material, when measured against the three principal political and economic benefits of this proposal. First as noted it will enable the EU to adequately financially support Ukraine’s defense against Russian aggression for several years on its own if need be. Secondly, as the cash to help Ukraine is already available at mostly EuroClear (as sanctions make it illegal for EuroClear to repay Russia its immobilized cash), the EU will simply give it an IOU instead, allowing it to balance assets and liabilities, meaning that the EU will not have to actually issue new Eurobonds in the markets itself to finance the aid to Ukraine. And thirdly, the EU will have established a direct political link between the Russian aggressor state and who pays for Ukraine’s war effort.
As political sausage making goes, this proposal is consequently more than good enough to satisfy the needs of both Ukraine, the EU and the G7/IMF. And certainly, the EU is not likely to be deterred by Russian threats to proceed with expropriation of remaining privately held European corporate assets in Russia. These are likely to have already been largely written down, and political leaders aiming to militarily deter Russia also in the long-run will likely welcome a further reduction in remaining economic ties
between Russia and the EU.
Jacob
