Brexit will trigger major structural reforms at the EU level affecting public expenditure across the bloc during the next multi-annual financial framework (MFF) starting in 2021.

• At a summit in Brussels on 22/23 February, EU leaders endorsed an increase in financial support to enhance the EU's internal and external defence and security capabilities.
• Likely post-Brexit cuts to the EU's Common Agricultural Policy spending and to regional and cohesion funds heighten the risk of political, electoral, investor, and trade union pushback within EU member states.
• In addition, fault lines between EU member states willing to increase national-level EU budget contributions and those opposing such moves are likely to deepen.
• Further complications are likely at a later stage, with the European institutions and EU member states looking unlikely to conclude MFF talks before the EU enters its new institutional cycle in mid-2019.

On 22 and 23 February 2018, EU leaders launched preparatory talks at a summit in Brussels about the bloc's post-Brexit public finance plan. Along with wider structural reforms and a review of public spending at the EU level, the latter has to reflect the revenue implications of Brexit and a resultant loss of roughly EUR10 billion (USD12 billion) per year of funding coming from the United Kingdom. The main focus here relates to the EU's next multi-annual financial framework (MFF), which will be launched in January 2021; this will organise EU expenditure until December 2027. At present, it is likely that an envisaged post-Brexit transition period will have ended by the start of the next MFF, but it remains unclear whether the UK will commit to selective payments into EU funds after its current budgetary commitments and long-term legal obligations are settled. This depends heavily on the final deal on future UK-EU relations.

Likely cuts to CAP, cohesion, and structural funds increase risk of member-state-level opposition

As a first step, a slim majority of the EU's remaining 27 member states have already committed to an increase in national-level payments into the EU budget from 2021. However, a number of net contributors such as Austria, Denmark, the Netherlands, and Sweden remain critical or are showing outright opposition to higher financial contributions. Nevertheless, EU leaders were able to agree on boosting expenditure on defence and security to enhance the bloc's internal and external capabilities in areas such as securing the EU's external borders, fighting international terrorism and illegal immigration, and strengthening EU defence mechanisms. This is largely in line with decisions taken at an EU summit in Bratislava (Slovakia) in September 2016 and the so-called Rome Declaration from March 2017. However, while the European Commission has secured member-state support for defence and security funding, other reforms face stronger opposition. For instance, it is highly likely that Common Agricultural Policy (CAP) spending, as well as the EU's regional and cohesion funds, will be cut as these three areas combined currently represent around 70% of EU expenditure. This policy direction was reconfirmed by European Commission President Jean-Claude Juncker and Budget Commissioner Günther Oettinger last week. As a result, there is a heightened risk of political, electoral, investor, and trade union pushback at the EU member-state level. In addition, it is likely that the EU institutions will try to link access to EU funds to member-state adherence to EU rules and values. Adding this degree of conditionality would particularly affect Hungary and Poland, both of which are entangled in longstanding conflicts with Brussels over issues such as the rule of law. These countries would face an elevated risk of losing EU subsidies as a consequence. This in turn increases the probability of deepening existing fault lines within the EU, for instance between founding members such as France and Germany on the one hand, which are broadly supporting the European Commission on this issue, and the so-called Visegrád Four group comprising the Czech Republic, Hungary, Poland, and Slovakia on the other.

Outlook and implications

The European Commission will publish its formal draft proposal for the next MFF no sooner than May 2018. However, considering that negotiations for the current MFF took 29 months to conclude, it is unlikely that the European Council and the European Parliament will agree on all details for the final budget framework with the Commission before mid-2019, when the EU will enter a new institutional cycle. As a result, a final decision is likely to be formed after the next European Parliament elections, likely to be held between 23 and 26 May 2019, and the inauguration of a new college of Commissioners, which probably will happen around October or November 2019. This increases the risk of further complications at later stages in the process as a change in European Parliament representation and new Commissioners could trigger policy reversal on previously agreed compromises. Any official statements coming from member-state leaders, finance ministers, and the EU level represent important indicators of the viability of envisaged EU reforms; such statements in particular would highlight potentially contrasting views on EU public spending reforms and the scope for policy deadlock. Further guidance in this regard is likely to emerge from bilateral meetings between leaders of member states, such as when Austrian Chancellor Sebastian Kurz met German Chancellor Angela Merkel in January 2018 and opposed her commitment to higher EU budget contributions. In addition, protests by civil-society groups or trade unions aiming to prevent cuts in affected sectors would be crucial indicators of potential national-level political impacts. IHS Markit would view EU member states showing a willingness to amend their previous stances on EU finances as positive signs favouring compromise agreements. In this regard, a public announcement by French President Emmanuel Macron endorsing reduced CAP spending would be a key risk-positive step. Macron has already alluded to his willingness to consider such reforms. Another important indicator would be a move towards a "softer" model for Brexit. This could alleviate financial pressure on the EU if the UK government were to commit to future post-Brexit EU budget contributions in the context of upcoming UK-EU negotiations on trade, due to commence by the end of March 2018, in turn reducing the need to enforce unpopular expenditure cuts.