Germany and France try to break deadlock over how to rescue the EU

London(CNN Business) Germany and France unveiled an initiative Monday aimed at rescuing the European Union from the toughest crisis in its history and bridging the deep national divisions that have stalled progress on a pandemic recovery fund.

After meeting via videoconference, German Chancellor Angela Merkel and French President Emmanuel Macron proposed the creation of a recovery fund worth €500 billion ($543 billion) that would help the EU countries and industries hit hardest by the coronavirus pandemic.

Merkel said the crisis threatened the cohesion of the European Union. The initiative by Europe's top two economies was aimed at helping achieve a consensus among all 27 EU member states, she added.

"To support a sustainable recovery that restores and enhances growth in the EU, Germany and France support an ambitious, temporary and targeted Recovery Fund," Merkel said, speaking at a video news conference.

Europe's ability to recover from the worst economic shock it has seen since the Great Depression has been jeopardized by the reopening of old political wounds.

Divisions among member nations have slowed progress on a recovery fund that the European Commission had hoped could raise at least €1 trillion ($1.1 trillion) to rebuild regional economies.

Charles Michel, president of the European Council of EU national leaders, had called for the package to be operational by June 1. But the Commission failed on May 6 to finalize its proposal.

Differences over whether the fund should provide loans or grants to the hardest-hit countries such as Italy and Spain stalled progress. Grants, or direct money transfers, would imply a degree of debt sharing that states such as the Netherlands, Austria and Germany have long resisted.

But Merkel and Macron confirmed that under their proposal, the European Commission would borrow money to boost the EU economy and channel the funds via the EU budget to the hardest-hit regions and sectors.

"Given the exceptional nature of the challenge of the Covid-19 pandemic for economies across the EU, France and Germany propose to allow the European Commission to finance such recovery support by borrowing on markets on behalf of the EU," Merkel added.

Macron said the EU recovery fund would enjoy the backing of the European Central Bank. While the fund would have to be repaid over time, that burden would not fall solely on those who need the help most.

"These 500 billion euros will have to be repaid," Macron said, but "not by the beneficiaries," he added.

Analysts said the agreement represented progress after weeks of division that risked stoking anti-EU sentiment in countries such as Italy that have been slammed by the pandemic. By offering grants rather than long term low interest loans, some of that political damage could be repaired.

"Of course, as recipients of funds will have to shoulder their share of additional contributions to the EU budget to service the EU debt, the net benefit will be lower than the gross amount of the grants they receive," wrote Berenberg chief economist Holger Schmieding in a research note.

But the Franco-German initiative still needs to be turned into a formal proposal by the European Commission, and agreed by all 27 EU member states, potentially at a summit on June 18.

"While it will not be easy to persuade the Dutch, Danish and Swedish governments to back the idea, we expect the French-German proposal to be the basis for a deal in the end," Schmieding added.

The European Union economy will shrink by a record 7.5% this year, the European Commission warned earlier this month, and the drop could be even more precipitous across the 19 countries that use the euro.

It's a much steeper decline than the region suffered following the 2008 global financial crisis, and a more pessimistic outlook than forecast by the International Monetary Fund in April.

Ursula von der Leyen, president of the European Commission, welcomed the "constructive proposal made by France and Germany."

EU Council President Michel called it a "step in the right direction" for the EU.

"I welcome Germany and France's efforts to find common ground on the recovery fund," Michel tweeted. "I call all 27 member states to work in a spirit of compromise as soon as the European Commission has tabled a proposal."

EU officials have warned that the pain could be even worse than forecast if the pandemic is more severe and long-lasting than currently envisaged.

EU leaders have already signed off on immediate rescue measures worth at least €500 billion ($538 billion), a package that includes wage subsidies aimed at preventing mass layoffs, as well as loans to businesses.

— Stephanie Halasz, Pierre Buet, Nada Bashir, Rob North and Charles Riley contributed reporting.