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09/12/2016

Italy and Spain test EU’s ‘intelligent’ use of economic rules

Euro & Finance

Italy and Spain test EU’s ‘intelligent’ use of economic rules

European Commission president Jean-Claude Juncker warned of the "political consequences" of a strict application of the EU fiscal rules.

[EUROPEAN PARLIAMENT]

The European Commission is expected to fine Spain on Wednesday (27 July), but it will give two extra years to Madrid to adjust its budget – while the commissioners pledge a solution for Italian banks that will protect small investors.

In the aftermath of the financial crisis, the EU strengthened its rulebook with thousands of pages of new legislation to better control member states’ economies and avoid costly bank rescues with taxpayers’ money.

But as Europe struggles to get out of the hole, the strict application of the rules could backfire in times of growing political discontent against Brussels.

Against this backdrop, the Commission now champions an “intelligent” implementation of the rules with Spain and Italy.

Around €360 billion in ‘bad loans’ has put the Italian economy, the third largest in the eurozone, in a very delicate situation.

Italy averts banking crisis with EU deal on bad loans

Italy and the European Union reached agreement on Tuesday (26 January) to help Italian banks sell bad loans, averting a major banking crisis which had been brewing for over a year.

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In the case of Spain, the Commission launched sanction procedures against the fourth largest economy in the eurozone for breaching the fiscal rules. The institution also opened a similar case against Portugal.

The executive is expected to punish Madrid and Lisbon on Wednesday (27 July) with the first fine in EU history for breaking the Stability and Growth Pact.

In the next few days, the Commission will also force Rome to come up with a bank rescue programme that will impose losses on citizens who invested in financial institutions, as the new Bank Recovery and Resolution Directive (BRRD) mandates.

Social unrest

But the executive is aware of the political backlash that could be triggered by a strict enforcement of the rules, just when the EU is dealing with the consequences of Brexit, the constant terrorist threat, the messy response given to the refugee crisis and the surge of populist forces across Europe.

Accordingly, the Commission is willing to ease the budgetary adjustment requested to Spain and is working on a solution to protect small investors, like pensioners, in Italy.

On the eve of the college meeting to decide the fine against Spain and Portugal, the commissioners split over imposing a symbolic fine of few hundred millions of euros or to cancel it altogether. The college did rule out to impose the maximum fine of 0.2% of GDP (around €2.1 billion for Spain and around €346 millions for Portugal).

In parallel, the European Parliament is ready to minimise the suspension of EU funds, also part of the sanction procedure against both countries.

MEPs step in to ease sanctions over deficit rules

The European Parliament’s intervention “would benefit” Spain and Portugal, as they face the freezing of millions in EU funds for having breached fiscal rules, sources told EurActiv.com.

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More importantly, the Commission will grant more time to Spain to cut its deficit below the mandatory 3% of GDP, as the fiscal rules stipulate.

Last May, the Commission said that Spain should meet the deficit target by 2017, by doing a structural effort worth €7.5 billion in new taxes or additional cuts by the end of next year.

But the latest data published by the Spanish independent fiscal authority (AIReF) in July forced the Commission to reconsider its recommendation.

AIReF said that the deficit is expected to reach 4.1% this year, and it could go up to 4.7% if a new government is not in place to adopt a €6 billion adjustments to the corporate tax announced by the Spanish government.

Against this backdrop, the Commissioner for Economic Affairs, Pierre Moscovici, told his fellow commissioners on 20 July that the best option would be to recommend two years, instead of one. This option was seen as the most likely scenario on the eve of the college meeting to be held on 27 July, sources told EurActiv.com.

As regards to the Italian banks, the new rules force to impose losses on investors of up to 8% of total liabilities (including capital) before public money may be used to bailout the entities.

Eurozone set for direct bank recapitalisation in 2015

The euro zone’s bailout fund, the European Stability Mechanism, could directly invest in a troubled bank next year, after 8% of the bank’s total liabilities are written off, the chairman of eurozone finance ministers said on Monday (5 May).

EurActiv.com

But a similar solution saw hundreds of thousands of small investors lose their savings in Spain’s banking crisis, as they thought they were offered a standard saving account by their banks. In a similar case, an Italian man killed himself last December after he lost all his savings when his regional bank was bailed in.

The Spanish case taught a lesson to the EU authorities. “Where burden sharing is going to be implemented within a programme, there is merit in taking into account the programme’s impact on consumers and retail investors,” a Commission’s report said last January.

A Commission spokesperson told EurActiv that “there is a number of solutions that can be put in place in full compliance with the EU rules addressing liquidity and capital shortages in banks without adverse effects on retail investors”.

The Commission is willing to use the precautionary recapitalisation option foreseen under the BRRD rules. Under this clause, pre-existing EU state aid rules, and a ‘lighter’ burden sharing would kick in.

The executive and the Italian government are working on a proposal expected for the coming days, as the European Banking Authority will publish the results of its stress test on the financial sector on 29 July.

Flexibility within the rules

Experts agree with granting the flexibility allowed by the rules, but not neglecting entirely neglecting those rules, in spite of the political circumstances.

Silvia Merler, from Bruegel, a Brussels-based think tank, pointed out that Brexit has been the external shock that showed how the Italian banking system was still weak, due to the fact that the non-performing loans had not been addressed.

“Italy can be granted BRRD flexibility that would limit the bail-in requirement compared to the standard case” she told this website. But nothing beyond this flexibility, otherwise “the credibility of the rules would be weakened”.

Friedrich Heinemann, from the Centre for European Economic Research (ZEW), a German think tank, believes that circumventing the rules is not the best solution to fight the rise of populism, but rather the opposite.

“Populists in Northern Europe have benefited a lot from a perception that, in the past, European rules have been not been respected”, he said.

In his view “political compromises” to water down the rules applied to Spain, Portugal or Italy “would further alienate voters in countries like Austria, Germany, Finland and Netherlands”.

Spain and Portugal pledge new measures to avoid EU deficit fines

Both Spain and Portugal have submitted their arguments to the European Commission in a bid to avoid penalties for breaching the fiscal rules, expected to be announced on 27 July.

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But the views are rather different in the affected countries.

“Sanctioning the past doesn’t make political and economic sense for countries that are already taking effective action, as in the case of Portugal,” Finance Minister Mario Centeno wrote in the letter sent to the Commission to avoid the fine.

“Every day I am more convinced that the sanction will be zero,” Spain’s acting Minister of Economy, Luis de Guindos, said in early July. “The reason why I am optimistic is the injustice that would represent imposing a sanction on Spain” in light of the efforts made, Guindos added.

Italian prime minister, Matteo Renzi, also backed Spain’s and Portugal’s stance opposing sanctions. “It’s absurd not to use common sense,” Renzi said in June.

Background

In 2013, Spain received three extra years to cut its deficit below the mandatory 3% of GDP of the pact.

Despite the fact that this was the third time Madrid had been granted leeway since 2009, the deficit reached 5.1% of GDP in 2015, higher than previously announced.

The European Commission's latest forecast predicts that the Spanish deficit will be 3.9% of GDP this year and 3.1% in 2017.

In April, the executive and the ECB concluded that the needed progress on fiscal consolidation in Spain "has come to a halt, with part of the structural adjustment implemented in earlier years being reversed".

Following the elections on 4 October, a three-party coalition led by the Socialist Party came to power in Portugal. The new government failed to submit its draft budget for 2016 by 15 October, as the EU’s fiscal rules said, and sent the draft proposal only on 22 January 2016.

After assessing the first draft, the Commission concluded that the budget was “in clear breach of the Stability and Growth Pact”, and requested more measures.

Portugal has been in the corrective arm of the Stability and Growth Pact since December 2009 and was asked to bring the deficit to below 3% of GDP by 2015. For 2016, the Council recommended that Portugal should make a structural effort of 0.6% of GDP.

Further Reading

European Commission

  • Opinions on "no effective action" taken by Spain and Portugal to meet their Stability and Growth Pact targets.
  • Country-specific recommendations on Spain and Portugal.
  • Spring economic forecast.

European Council