If adopted and implemented by the EU, the European Commission's legislative proposals on economic governance will constitute a new way of coordinating economic policies in the bloc, writes Nicolaus Heinen, an analyst at Deutsche Bank Research.
This analysis was authored by Nicolaus Heinen for DB Research.
''On 29 September, following consultation with the Van Rompuy Task Force, the May and June Commission communications on economic governance culminated in several legislative proposals. If adopted, the total of five regulations and one proposal for a directive are likely to change the face of European economic governance more comprehensively than any other reforms since the launch of EMU.
The Commission has done a good job. The six legislative proposals that have now been submitted are a consolidation of the Commission's communications of this May and June following coordination with the Van Rompuy Task Force. Three proposals for a regulation deal with the Stability and Growth Pact (SGP). Added to these are a proposal for a directive to improve national budgetary frameworks and proposals for another two regulations to reduce macroeconomic imbalances in the euro area.
There are some key points common to all the proposals.
- The requirements of common fiscal policy and ways of addressing macroeconomic imbalances are more closely interlinked.
- Tougher sanctions are a pivotal element. As a rule these take the form of deposits, either interest-bearing or non interest-bearing depending on their area of application.
- These sanctions will kick in as soon as the Commission determines that a country is in breach of its commitments and provided the Ecofin Council does not reject this by a qualified majority within ten days. The Commission calls this mechanism 'reverse voting'.
Unlike the controversial reform of the SGP in 2005, the previous sanction mechanisms are not to be replaced. Three proposals for a regulation enhance the existing sanctions in the corrective part of the SGP and introduce new means of sanctioning in the preventive arm as well.
- Preventive arm: EMU states that fail to meet the targets set for their medium-term structural budget deficit (known as the 'Medium-Term Objective'; MTO) may not permit their public spending to increase faster than the potential growth rate of their economy. The more the actual structural deficit deviates from the medium-term objective, the more stringent the restrictions that may be imposed. This is designed to ensure that additional revenues are used to consolidate budgets rather than being spent. Upon the issuance of a recommendation by the Commission, sanctions are to be imposed in the form of interest-bearing deposits amounting to 0.2% of GDP (reverse voting).
- Corrective arm: A sanction in the form of a (non-interest-bearing) deposit equalling 0.2% of GDP will be imposed as soon as the excessive deficit procedure (EDP) has been initiated and the Commission has issued a recommendation. If the member state fails to comply with the recommendations by the Commission, the deposit may be converted into a fine of up to 0.5% of GDP. The previous waiting period of at least 16 months until sanctions are imposed no longer applies.
That is not the only new feature. In future the EDP is to be expanded to encompass public debt levels. The proposal stipulates that member states whose debt exceeds the benchmark 60% of GDP must reduce the debt overshoot by at least 5% p.a. of the difference from the 60% threshold over the previous three years.
As the indicator is retrospective, it will be applied only gradually for the first three years in which the regulation is effective. [This could place] additional pressure for fiscal consolidation […] on euro-area members. Germany and France could each face annual consolidation efforts of more than EUR 26bn, Greece EUR 8.6bn and Spain EUR 6.5bn.
Sanctions apply for EMU countries within the EDP. However, they do not apply automatically, as an EDP is not opened if other factors – such as a low nominal growth rate, private sector indebtedness or ageing-related burdens for the public budget – render a reduction of debt levels difficult. This exemption makes the agreement of countries like Belgium, Italy and Greece to this part of the proposal more likely – but render this part of the proposed reform somewhat weak.
Without prudent national budgetary frameworks the Stability Pact is a toothless tiger. A proposal for a new complementary directive therefore sets out to harmonise these national underpinnings for the SGP. It provides for uniform minimum standards in accounting systems, forecasting practices, budgetary procedures and fiscal rules. But the proposal goes even further than that with requirements designed to ensure that, going forward, national budgetary frameworks reflect the objectives of the SGP – including multi-year fiscal planning. The proposal thus clearly embraces national fiscal rules along the lines of Germany's debt brake.
The package of measures also contains two proposals for regulations to prevent and correct macroeconomic imbalances within the EU and the EMU. Along the lines of the EDP, the Commission proposes an excessive imbalance procedure kicking in if a regular evaluation of imbalances via fixed indicators shows that harmful macroeconomic imbalances persist. Similar to the EDP the Commission will give recommendations to the member states (reverse voting). There are to be annual fines of 0.1% of the GDP for EMU member states.
Degree of Implementation still open
The Commission's proposals are a milestone on the path to results-oriented and performance-related macroeconomic governance in the EMU. Yet, how feasible is their implementation?
- The measures to lower the excess debt on an annual basis as well as the strict focus on public expenditures are to be decided under the 'special legislative procedure'. So Ecofin [EU finance ministers] has to vote unanimously on this regulation while the [European] Parliament has only a downstream role. In this case, usually, Ecofin's position is incorporated in the Commission's proposals to avoid a political defeat. Therefore we are confident that there will be only minor changes to the proposal during the next [few] weeks.
- Four additional regulations are to be adopted according to the 'ordinary legislative procedure' with a qualified majority in Ecofin (55% of the member states containing at least 65% of EU population). The Parliament has to be consulted as well. As a consequence, those regulations – i.e. depository rules, sanction prescriptions or the rules of macroeconomic governance – might receive fundamental changes.
- The planned directive for national budget planning requires a majority as well. However the Parliament gives its opinion only.
Considering all these facts, only the extension of the deficit procedures and the bold rules concerning deficit lowering are feasible. Yet it should be taken into consideration that the Commission has not conjured up its proposals out of thin air. They are the result of talks ('informal trilogue') [between the] Commission, [the] Council's Presidency and [the] Parliament.
In this case the Van Rompuy Task Force's involvement might have been substantial. As a consequence, changes – e.g. as regards necessary majorities within the reverse voting procedure – are quite possible. Nevertheless, given the pressure arising from stressed national budgets and intense observation by sovereign debt markets among EMU countries, these changes will be only gradual.
We anticipate a timely adoption of the three regulations on the SGP such that they can already be implemented within the first European Semester from January to July 2011. The approval of the two regulations on macro-imbalances could take somewhat longer, as macro-imbalances could still be discussed within the next mandate of the Van Rompuy Task Force.
Given the huge exemptions as regards the application of the EDP on public debt levels, a fast implementation seems feasible. The approval of the directive on national budgetary frameworks could take longer as this would imply more changes to national legislation.
A draft directive being comparable as regards the degree of political will was the 'Omnibus Directive' amending financial services legislation to ensure the operation of the European System of Financial Supervisors. After being proposed on 26 October 2009, it will be approved by the Council by the end of this year. If we assume a similar time schedule, a rough guess on the date of approval for the directive on national budgetary frameworks is December 2011.
The most recent German suggestion to withdraw the voting rights of countries with constant deficits in some of the Councils would have required amendments to the Treaty. A more subtle and genteel approach circumventing the need for amendments of the Treaty is the German and French proposal to politically neutralise the effect of votes of certain Euro states via informal agreements before a voting procedure.
The Commission's proposals constitute a new way of coordinating economic policies in the EU. If implemented as proposed, they will result in EMU countries becoming subject to stricter evaluations and sanctions – and EMU will turn more and more into a 'Core Europe' as regards economic integration.''