EU Commission urges member states to invest more

Valdis Dombrovskis, Executive Vice President of the European Commission and European Commissioner Paolo Gentiloni give a joint press conference on the fiscal policy guidance for 2023 at the European Commission in Brussels, Belgium, 02 March 2022. [STEPHANIE LECOCQ / EPA-EFE]

With insecurity for the European economy substantially increasing due to Russia’s war of aggression in Ukraine, the EU executive called on countries to keep investing in economic growth and remain open about an eventual prolongation of the suspension of fiscal rules.

The so-called “fiscal guidance” by the EU Commission for the year 2023 was presented by executive vice-president Valdis Dombrovskis and commissioner Paolo Gentiloni on Wednesday (2 March). It is meant to provide recommendations to member states who are planning their budgets for 2023.

The guidance was long expected by member states as the EU was expected to return to stricter fiscal rules that were suspended by means of a general escape clause to allow member states to react to the pandemic.

However, Russia’s attack on Ukraine casts a renewed shadow of insecurity over the future economic developments.

“After a strong EU response to the pandemic, we are facing new uncertainty with the barbaric Russian aggression in Ukraine, coupled with existing challenges such as inflation and high energy prices,” vice-president Dombrovskis said, adding that the EU’s sanctions would “inevitably” have negative consequences for the economy.

Good fundamentals

Nevertheless, the Commissioners argued that the fundamentals of the EU economy were good. The risks of the Russian war to the EU economy are limited by the fact that only about 4% of EU exports go to Russia.

Commissioner for the economy Gentiloni said: “We do not expect the recovery to derail completely, but to be weakened.” He called for a close cooperation of member states’ fiscal policies at EU level.

The Commission underlined the importance of promoting growth through investment. A senior EU official explained of the Commission’s stance: “Too abrupt consolidation could negatively impact growth and, thereby, debt sustainability.”

The EU executive differentiated between highly indebted countries and less indebted countries. While member states with low levels of debt relative to GDP were encouraged to keep an expansionary spending policy, states with higher levels of debt were encouraged to keep the growth of their current spending in check.

Cut current expenditure, not investment

Highly indebted countries should also refrain from cutting investment, the Commission said. With this stance, the Commission is echoing the arguments of the French and the Italian governments who say that debt levels can only be brought down through high economic growth.

Nevertheless, the Commission argued that, for now, the Commission still planned to revert back to most of the fiscal rules in 2023. The most commonly known among these rules are the goal to keep government debt levels below 60% of GDP and annual budget deficits below 3% of GDP.

“Member states with a planned breach of 3% of GDP the deficit threshold in 2023 and beyond should outline their planned policy measures to bring it below the threshold,” a senior EU official said.

This concerns, for example, the Italian government that is currently planning to run a budget deficit of above 3% of 2023.

Another look at fiscal rules

Due to the economic uncertainty, however, the Commission announced that it would take another look at the question whether to reapply the fiscal rules in May when the new economic forecasts are available.

Moreover, the Commission plans to ignore one crucial and much-criticised fiscal rule for 2023, namely the requirement that countries with debt levels above 60% of GDP should reduce their debt levels by 1/20th of the difference between their current level of debt/GDP and 60%.

For highly indebted countries like Italy this rule would mean that it would have to reduce its debt by 5% of GDP every year, which is virtually impossible.

The deletion of the 1/20th rule is not expected to encounter much resistance, even from fiscally more hawkish governments. Even the German finance minister’s chief economist, and well-known fiscal hawk Lars Feld said that deleting this rule could be a part of a future compromise on fiscal rules between EU member states that advocate for a more expansionary fiscal policy and more hawkish governments.

A more thorough reform of the EU’s fiscal rules is currently debated between EU governments and the Commission. The Commission is expected to present its proposals for this reform in the coming months.

[Edited by Nathalie Weatherald]

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