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Commission inches towards Berlin in EU debt rules proposal

The European Commission presented its legislative proposals for a reform of the EU rules for national debts and deficits on Wednesday (26 April), moving closer to the position of Germany but keeping the key concept of country-specific debt reduction plans

By: EBR - Posted: Thursday, April 27, 2023

Thirdly, while the adjustment period should normally be limited to four years, it can be extended to seven years only “if underpinned by reforms and investments”, the senior official said, which would have to be growth-enhancing and in line with EU priorities, such as the Green Deal.
Thirdly, while the adjustment period should normally be limited to four years, it can be extended to seven years only “if underpinned by reforms and investments”, the senior official said, which would have to be growth-enhancing and in line with EU priorities, such as the Green Deal.

by Jonathan Packroff 

The Commission’s legislative proposal follows a discussion among EU countries after the Commission had presented an initial set of ideas on how to reform the EU’s fiscal rules (“Stability and Growth Pact”) in November 2022.

The reform aims to make debt-reduction programmes more realistically attainable and improve their enforcement.

“For 25 years, the Stability and Growth Pact has provided common rules, and it was essential to underpin the Economic and Monetary Union,” Paolo Gentiloni, the EU commissioner for the economy, said on Wednesday.

“Yet, the Pact’s shortcomings have also been all too evident”, Gentiloni added. Of note, public debt levels, which normally should be limited to 60% of GDP under the original rules, have reached an average of 90% of GDP across the bloc.

Investment levels, which are expected to spur economic growth, have continuously gone down since the 2011 euro crisis, while economic growth performance remained particularly low over the past two decades, Gentiloni said.

As such, the current debt rules were seen by many as fuelling low economic performance rather than boosting it through relevant and tailored debt-reduction programmes.

What the reform entails

Rather than the current one-size-fits-all approach, the Commission now proposes to give highly-indebted member states more time to bring their debt levels closer to the 60% of GDP threshold.

The 3% budget deficit rule, enshrined in the Treaties, remains fully in place.

Specifically, the reform does away with the historic “1/20 rule”, which stipulated a highly-indebted member states would have to reduce 1/20th of the difference between the 60% and the country’s actual debt ratio every year, a rule which was found to dampen economic growth altogether.

Instead, member states would now follow country-specific “medium-term structural plans”.

These will be negotiated between the Commission and the member state in question, on the basis of a country-specific Commission proposal, known in the jargon as a ‘technical trajectory’.

These announcements, initially made back in November in a Commission Communication, have been met critically by some member states, most notably Germany, for which this ‘bilateral’ approach might create a risk that countries do not sufficiently reduce their public debt level, with the Greek debt crisis still weighing on many minds.

German Finance Minister Christian Lindner has therefore repeatedly called for “common safeguards”, which in his view should include a minimum annual debt reduction target that applies to all countries.

Furthermore, Germany was critical of the fact that the initial Commission proposal would have allowed for an adjustment period of four to seven years, in which even highly indebted countries would not have to reduce their public debt levels.

Instead, they would have only been obliged to be on a “plausibly declining path” towards lower debt levels from the end of the period onwards.

A step towards Germany, but not all the way

With Wednesday’s proposal, the Commission makes a step towards Germany’s position, however, without going all the way.

The legislative proposal includes four new so-called “safeguard provisions”, a high-ranking Commission official said.

These would include the need for public debt levels to be lower at the end of the adjustment period than at its beginning.

Further, over the term of the plan, the growth in governments’ “net expenditures” could not surpass the economic growth that the country experiences.

“Net expenditure” includes all public spending without interest payments or cyclical unemployment benefits, but with the option to finance additional expenditure through tax increases.

Thirdly, while the adjustment period should normally be limited to four years, it can be extended to seven years only “if underpinned by reforms and investments”, the senior official said, which would have to be growth-enhancing and in line with EU priorities, such as the Green Deal.

“Member states will not be allowed to push back fiscal adjustment to a later date,” Valdis Dombrovskis, the Commission vice president for “an economy that works for people”, stressed when presenting the proposals.

Lastly, a minimum debt reduction of 0.5% of GDP per year was included in the proposal, but only for those countries where the annual deficit exceeds the 3% limit set in the treaties.

In an unofficial position paper sent to the Commission earlier this month, the German government had proposed a minimum debt reduction of 1% of GDP per year for all highly indebted countries.

“The question is, in a sense, finding the right balance between having more leeway for member states to set their fiscal structural plans and their fiscal adjustment trajectories – and ensuring transparency and equal treatment,” Dombrovskis said.

Stronger enforcement of the rules
To calm critics of the reform, who fear that the proposal ultimately loosens debt-reduction obligations, both commissioners highlighted that the enforcement of the rules will be made more “credible”, meaning that sanctions would actually be imposed.

In the past, fines were possible in the case of a breach of the EU rules but have never been applied in practice.

“There are some bottlenecks in this regard,” Dombrovskis said. Specifically, in countries where debts or deficits exceed the allowed level, having to pay an additional fine could make the situation worse, he admitted.

“That’s why lowering the sanctions makes them more realistically enforceable,” Dombrovskis added.

“What we had was essentially an atomic bomb, which no one wanted to use because if you would use it, it would actually make the situation worse,” the Commission official said. “By lowering the sanctions, you reduce the threshold for applying these sanctions quite significantly”, he added.

After Wednesday’s proposals, the reform will have to be discussed in both the European Parliament and by member states of the Council. EU institutions aim to finalise the procedure by the end of this year so that the country-specific plans could be developed in 2024.

[Edited by Theo Bourgery-Gonse/Zoran Radosavljevic]

*first published in euractiv.com

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