Clash on EU spending rules

The recent crises prompted even frugal countries like Germany or the Netherlands to take on large amounts of public debt, leading to calls for reform. The bloc’s strict debt and deficit rules, known as the Stability and Growth Pact, have been temporarily suspended because of the Covid-19 pandemic, and this suspension was extended due to the sky-high energy prices, a fallout of Russia’s war against Ukraine.

The previous rules are set to apply again from 2024. However, the European Commission proposed granting highly indebted European countries more flexibility in reducing debts and deficits.

“We simultaneously ensure both equal treatment and consideration of country-specific situations,” the EU Commissioner for Economy Paolo Gentiloni told a news conference at the end of April.

According to the EU’s current spending rules, the public deficits of member states must not exceed 3 percent of their gross domestic product, and debt should stay below 60 percent of GDP. Under these rules, states must pay back 5 percent per annum of the debt exceeding the 60 percent mark. For highly indebted countries, this is devastating for growth. The rules date back to the 1990s and were often disregarded even before the pandemic. They were also to be reformed before then.

The current reform proposal retains the previous goal of limiting debt, but there will be more flexibility through country-specific plans for debt reduction. Positions on the debt rules and the new proposals are very different in the individual EU states. The “frugal” northern countries, including Germany, want the rules to remain strict, while southern states like Italy say they constrain their ability to invest. EU member states’ debts have rocketed in the past 15 years. The EU aims to conclude an agreement by the end of this year.

Berlin calls for binding targets

Germany, a staunch defender of fiscal discipline, fears the reform will overly relax the European Union’s budgetary constraints and undermine fairness within the bloc.

German Finance Minister Christian Lindner hit out at the changes.

“Germany cannot accept proposals that amount to a weakening of the Stability and Growth Pact,” he said, adding “significant adjustments” were needed.

Lindner’s objections resembled a “recipe of the past,” a European Commission official said.

Referring to the reform on the EU fiscal rules, Commission Vice-President Valdis Dombrovskis argued that “we live in a very different world than 30 years ago. Different challenges, different priorities.” The new rules would have to reflect these changes, he added.

France and Germany disagree

The commission also appeared to try to satisfy Germany with a proposal that says member states must reduce their deficit by 0.5 percent per year if it exceeds 3 percent of GDP.

But France was not happy with the change. The country’s debt stands at around 110 percent of GDP.

“Certain points go against the spirit of the reform … We are against uniform automatic rules for reducing the deficit and debt,” French Finance Minister Bruno Le Maire said at the end of April. The compromises proposed by the commission still provide for a “general escape clause” in the case of a severe economic crisis.

Majority welcome country-specific approach

Belgian Finance Minister Vincent Van Peteghem said he very much welcomed the proposal, especially the country-specific approach laid down in the rules. He said reducing debt while focusing on investments and reforms was essential. The current Belgian government wants to get back in line and reduce deficit to 2.9 percent by 2026. It aims to cut deficit by 0.8 percent a year between 2024 and 2026.

Dutch Finance Minister Sigrid Kaag said her country was “quite enamoured” by the plans, but stressed the importance of “credible debt reduction” and oversight. “The devil is always in the details,” she added.

Spanish Finance Minister Nadia Calviño, who will oversee negotiations in the second half of the year, said she would do “everything possible” to approve the new fiscal rules this year. Spain will take over the EU Presidency in the second half of 2023 and welcomes the country-specific approach in the commission’s proposal. Meanwhile, Brussels and Madrid disagree on Spain’s deficit forecasts. The Spanish government has calculated that it will reduce its deficit to 3 percent in 2024, as required by EU fiscal rules that will be applied again next year. The commission, however, has estimated that Spain’s public deficit will increase to 3.3 percent in 2024.

From Rome, Economy Minister Giancarlo Giorgetti hailed the commission’s legislative reform proposal as “a step forward” that would make it possible not to go back to the old Pact. Giorgetti, however, did not hide his disappointment at the failure of the so-called “golden rule”, which would have allowed to deduct strategic investments from the accounts. “We had strongly demanded the exclusion of investment expenditure, including those typical of the Digital and Green Deal NRP (National Recovery Plan), from the calculation of target expenditure against which compliance with the parameters is measured. We note that this is not the case.” On the basis of some technical simulations circulated in Brussels, the adjustment of the Italian accounts could lead to a reduction of the structural deficit by 0.85 percent per year in the case of a 4-year plan and by an average of 0.45 percent in a 7-year plan. At the same time, Italy is the only country that did not ratify the European Stability Mechanism (ESM) and aims to link the ratification to the outcome of negotiations on the Stability and Growth Pact. “If you start linking everything with everything, it becomes more difficult to make progress,” warned Commissioner Valdis Dombrovskis.

Romanian Minister of Finance Adrian Câciu argued that the package should strike a balance between “sustainability (sound public finances) and inclusive and sustainable economic growth (needs for reforms and investment).” He added that the new framework should create sufficient conditions to stimulate investment in member states with economic difficulties or a precarious fiscal space.

Today, Italy’s debt stands at 144,4 percent of GDP, while Belgium is expected to have a debt burden of 106 percent by the end of this year – well above the bloc’s limits.

Slovenia and Croatia: Methodology tougher on smaller states?

Slovenia, on the other hand, fears that it is hard to come up with a common methodology to measure debt levels, due to the huge differences between member states. “When it comes to this, the commission’s base proposal is not particularly to our liking,” Finance Minister Klemen Boštjančič said in Brussels on May 16. However, the country welcomed the proposal’s approach to focus on monitoring debt developments rather than structural deficits, mainly because the latter were very difficult to calculate and the results could also vary a lot, depending on the methodology, the minister said. Slovenia’s main concern is that, regarding the methodology, the commission could be tougher on small member states.

Croatian Finance Minister Marko Primorac said his country was satisfied with the current rules and supports the new proposal aimed at boosting public debt sustainability and giving member states greater autonomy in running their fiscal policies, but it finds the proposed model of sustainability analysis unacceptable as it would put Croatia among high-risk countries. “We find the current system absolutely acceptable as well. We are not in breach of the existing rules, but we fully support any improvement to increase transparency and simplicity in applying the methodology,” Primorac said on Tuesday in Brussels after the meeting of EU finance ministers. According to Primorac the debt sustainability analysis is “a very complex model based on a series of assumptions which, when incorporated into the model, categorise Croatia as a high-risk state when it comes to the amount of public debt. Given our fiscal situation, this classification does not apply to us.” He pointed out that there was no reason to classify Croatia as a high-risk country when it came to public debt sustainability given the country’s very good fiscal results.

Bulgaria works to join eurozone

Bulgaria still hopes to join the eurozone by 2025 and to stay below the 3 percent deficit threshold. In 2022, Bulgaria’s debt amounted to 22.9 percent of GDP, according to preliminary data published by the National Statistical Institute in late April. Nikolay Vassilev, former deputy prime minister, said that there would have to be measures regarding the expenditure side of the draft budget to achieve a lower deficit. The fiscal reserve as of March 31 amounted to the equivalent of over 6 billion euros.

ECB and IMF

The European Central Bank (ECB) and the International Monetary Fund (IMF) welcomed the EU’s proposals to overhaul its fiscal rules to boost growth, but the IMF called for more action.

ECB President Christine Lagarde said on April 26 that the bank appreciated the “commission’s effort to reach a compromise with member states because that is already unsure given the balancing act that you see in the documents.” Lagarde also pointed to the “differences and disagreements between countries because they face different challenges.”

Next steps

The EU could reform the pact by the end of the year. No one wants to go back to the old governance and no one wants to give a message of uncertainty about EU rules to the markets. A first formal round table on the pact is expected at the Ecofin meeting in mid-June.

This article is published Fridays. The content is based on news by agencies participating in the enr.