Draghi on quest to challenge EU rules and grow out of public debt

Draghi stressed that “there is no alternative to state intervention to achieve the ecological and digital transition. If the state isn’t present, these two transitions won’t happen”. [EPA-EFE/MASSIMO PERCOSSI / POOL]

Italian Prime Minister Mario Draghi unveiled an ambitious Italian budget for 2022-2024 last week, with deficits above the limits set by the Stability and Growth Pact, in what appears to be a bet on a change in the EU’s fiscal rulebook.

Early in the pandemic, the European Commission triggered the general escape clause of the EU’s Stability and Growth Pact, suspending the rules designed to reign in government spending in member states. However, the suspension will only last until the end of 2022 and, from 2023, the rules are expected to be enforced again unless member states change them.

Draghi presented plans for a budget deficit of 9.4% of GDP for 2021, lower than had previously been expected, after the economic growth forecast was revised upwards from 4.5% to 6%.

This strong growth should also lead to a slight reduction of Italy’s debt/GDP ratio, which Draghi said was a sign that economic growth is the most effective way to reduce public debt.

“[It] is the first confirmation of the fact that the way to exit the problem of high public debts is, first of all, growth. […] Many of us have been saying it for a while, but this is the first quantitative confirmation”, Draghi said.

The Italian government has targeted a budget deficit of 5.6% of GDP. next year. In 2023 and 2024, budget deficits of 3.9% and 3.3% respectively are planned.

Economics professor Gustavo Piga described Draghi‘s proposals as “austere“ and regretted the pace of fiscal consolidation – bringing the budget deficit down from 9.4% to 3.9% within only two years.

These budget numbers are still above the levels set by the EU’s Stability and Growth Pact, which mandates budget deficits not to exceed 3% of GDP. The fiscal rules also state that public debt levels should not be higher than 60% of GDP, a level exceeded by half of EU member states.

Signalling that he expects a change of the EU rules, Draghi described them as “unrealistic” at the budget press conference on Wednesday (29 September).

In early 2020, the Commission carried out a review of the rules in the Stability and Growth Pact with a view to reforming them, though that process was then suspended during the pandemic.

Review of rules on the cards

Earlier this year, Economy Commissioner Paolo Gentiloni and Commission Vice-President Valdis Dombrovskis announced their intention to take up this process again, stating the need to allow for more growth-enhancing investments in the EU framework and make it more counter-cyclical.

Marco Buti, Gentiloni’s head of cabinet, told a debate on Thursday that reforms should make it possible to distinguish between productive and less productive investments. This should ensure that the fiscal rules do not hold constrain the long-term growth of Europe’s economy and its transition towards a more sustainable model.

Although Buti admitted there was “no scientific underpinning” for the current ceilings of 3% for the deficit and 60% for public debt, he argued that political capital should be spent on changing the implementation and increasing the flexibility of the rules, instead of attacking them on principle.

While eight national governments have signed a statement calling for a return of the fiscal rules, governments such as Draghi’s have no intention to let the old rules stifle their economic growth. French Finance Minister Bruno Le Maire also called for new rules earlier this year.

For the Austrian finance ministry, one of the loudest defenders of the fiscal rules, it is important that the SGP is applied again after the crisis. Although it did not want to comment on Italy’s budget plans, it pointed out that the rules’ requirements should be reflected in national budgets.

“Politically, it is often easier to give in to the many wishes for additional spending. The art is basically to weigh up which measures are growth-promoting and sustainable and which measures endanger debt sustainability”, the Austrian finance ministry stated.

Growth vs ‘useless spending’

Draghi himself echoed this sentiment by stressing the need to differentiate between growth-enhancing spending and other expenditure at Wednesday’s press conference.

“We will have to pay attention to which measures contribute to an equal, lasting and sustainable growth and which ones are useless towards this equal, lasting growth”, he said.

Christopher Glück, Europe Director at Forefront Advisers, a political risk consultancy, said the most probable reform to the fiscal rules would involve allowing for more investments in the green transition and economic growth.

“Draghi wants to grow Italy out of his debt. For this, he is using his personal credibility to persuade Europe to agree to a slower path of fiscal consolidation where reforms are supported by public investment,” Glück said.

“This will feed into the discussion on the fiscal rules, including giving member states some leeway to deviate from the stringent debt reduction requirements so long as they make growth-enhancing investments, in particular to support the green transition,” he added.

The Commission is now coordinating with member states before proposing reforms to the fiscal rules in the first half of 2022. This will also be influenced by the composition of the future German coalition government, and the new Dutch government, as Holland was a staunch defender of low deficits, but is now stuck in complicated coalition talks.

[Edited by Zoran Radosavljevic and Benjamin Fox]

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