By Rebecca Christie
BRUSSELS- Europe’s new budget rules can work only if Brussels can stretch them. 11 countries including France, Italy and Belgium, posted 2023 deficits above 3 percent of GDP, the official high water mark for debt. But not all of them may end up being sanctioned. The regime includes ample wiggle room, allowing countries plenty of time to adjust. That’s good news for a bloc that needs growth more than guardrails.
To keep up with the United States and other global competitors, the 27-country European Union needs to square a circle. It has to grow faster than the anemic 1.4 percent annual expansion the bloc has averaged since 2006. But it also needs to fund the green transition and increase defense spending. And it can’t abandon the fiscal safeguards built into the bloc’s founding treaties that limit government borrowing and aim to cap member states’ total debt at 60 percent of GDP.
At first sight, the exercise got off to a shaky start: last month European Commission data showed that more than a third of EU countries, including heavyweights France and Italy, had gone above the deficit limit. But the new budget rules put in place in April allow countries at least four years to cut back on red ink before they face sanctions that could include fines or a loss of EU funding.
The Commission, the EU’s executive arm, is due to put out its official assessments of those found to be in breach of the new rules in June. Countries will have until around November to show how they plan to act.
Markets have so far been calm, and the gaps between the bond yields of countries with big deficits and those of Germany have been relatively stable. Still, the stakes are high. The whole point of having EU-wide fiscal rules is to prevent governments from spending their way into fiscal crises that can affect the whole of the bloc. Yet, even with the old, stricter, rules, between 2010 and 2015, budget problems in Greece spilled over into a crisis that caused five countries to seek bailouts and threatened the viability of the single currency. At the same time, straightjacket number-crunching, as fostered by the previous Stability and Growth Pact, risks forcing countries to cut spending and raise taxes in ways that entrench, rather than alleviate, economic difficulties.
The new regime’s first test looks daunting. The rules require countries with a deficit of more than 3 percent of GDP to make a fiscal adjustment — lowering their budget balance under a country-specific plan — of at least 0.5 percent of GDP a year. Some critics worry this will rein in spending too much and prevent countries from making the investments needed to pull their economies upright, while others fear the emphasis on annual deficits will take the focus away from reducing total debt levels.
The 11 countries now at risk of official “excessive deficit” rulings show the breadth of the challenges ahead. Italy recorded the bloc’s highest deficit shortfall in 2023, at 7.4 percent of GDP. That figure is expected to fall to a still sizeable 4.4 percent in 2024. Nevertheless, the reduction gives Prime Minister Giorgia Meloni momentum as she puts together a plan to keep the numbers moving in the right direction. For Spain, its 3.6 percent deficit last year is projected to fall to 3 percent in 2024 alongside a healthy 2.1 percent economic growth rate, enabling Prime Minister Pedro Sánchez to argue that it could squeak under the limit and not need corrective procedures at all.
On the other hand, France’s budget deficit clocked in at 5.5 percent of GDP in 2023, and it’s projected to be 5.3 percent in 2024 and 5.0 percent in 2025, while the economy is forecast to grow at just 0.7 percent and 1.3 percent , in those two years respectively. This is exactly the sort of lackluster fiscal improvement that backers of more stringent mechanical limits want to avoid. In their view, the new rules might encourage government to kick the can down the road, or to the next sets of politicians, despite explicit “no backloading” provisions to avoid delays in deficit reductions.
The International Monetary Fund — which has warned Europe that its puny growth prospects are a big threat to economic stability — has cautioned that countries shouldn’t be allowed to plan all their changes into the later years of the planned adjustment periods, lest they get caught up in a perpetual cycle of extension.
And yet the new rules may have just enough flexibility to work. Take, for example, member states like Spain and the Czech Republic, which were over the deficit limit in 2023. For them, rosier 2024 budgetary projections may mean they will sidestep the sanctions process altogether. The longer horizon also offers opportunities for traditionally frugal countries like Finland, which is expected to join the over-3 percent club this year, due to extra defense spending in response to the war in Ukraine.
