Macroeconomics Ecofin reaches an agreement to reform fiscal rules

The EU Economy and Finance Ministers reached an agreement this Wednesday for the reform of economic governance and the establishment of a new series of fiscal rules from 2024. The compromise text must now be negotiated with the European Parliament, which has much bigger ambitions, but all parties involved are confident of having the new framework in place in the first quarter. It will be a different one, but less than expected. The great objective of this negotiation, which has lasted all year, was to deviate from a battery of principles, limits and sanctions that have never worked in practice and move towards paths much more focused on spending rules, national responsibility and a commitment to fiscal consolidation hand in hand with investments, reforms and growth. The German demands, however, have made the result reminiscent in many points, and in some of its most inefficient strategies, of what already existed: maintaining the potential GDP framework, an obligation to reduce the annual deficit by 0.5 % of GDP, a debt reduction also constant for all between 0.5 and 1% and even tightening the belt even more even when countries are within the tolerated margins.

The ministers met this afternoon by videoconference to finalize the final details. 12 days ago they were very close in Brussels, but they still had some discrepancies, having to refine the last amounts, and several said they needed to consult with their bosses before making a decision. Yesterday, the Frenchman Bruno Le Maire and the German Christian Lindner, unofficial representatives of the two positions on the table, the hawks of stability and the doves of investment and growth, had dinner together in Paris, and closed the two issues that most were concerned: the speed of adjustment within the preventive arm, that is, at what pace will countries that are below 3% have to continue reducing deficits, to generate a cushion of at least 1.5% of GDP during the good times. And what margin of deviation will each capital have regarding that annual spending rule that will be the central element with which the European Commission will monitor the adjustment paths.

In 2024, a large part of European countries will enter an excessive deficit procedure, and therefore within what is known as a corrective arm, because after three years of suspension of the Stability Pact due to the pandemic, the war in Ukraine and the energy crisis, expenses have triggered debt levels and imbalances. Everyone counts on it. The key was how to return to the thresholds considered acceptable without compromising growth, employment and multi-billion dollar investments that are essential for the green and digital transition and for defense spending, a priority reinforced by the Kremlin’s expansionist belligerence.

“The agreement on fiscal rules is important and positive news; it will give certainty to the financial markets and will reinforce confidence in the European economies. The Spanish Presidency has led a negotiation process that culminated today in the agreement of the finance ministers of the 27 Member States, thus fulfilling the mandate of the European Council,” said the First Vice President and Minister of Economy, Trade and Business, Nadia Calviño. The ambassadors of the 27 will polish the last details in the coming days before the full text of the consensus is published.

Based on the proposal of the Community Executive, four types of safeguards have been introduced throughout the negotiation “to guarantee the sustained reduction of debt, the counter-cyclical impact, a system of control and supervision of these fiscal rules plus realistic and more effective and, at the same time, protection for public investments that correspond to European priorities in the green, digital, social and defense fields.

Although the spirit of the reform has been amended and diluted with these safeguards, the structure of the rules does represent a change. Based on the experience of the Recovery Plans of the Next Generation Funds, the new framework gives much more prominence to countries, which instead of receiving standard instructions from Brussels, regardless of the circumstances, will have to present their own fiscal plans with paths adjustment period of four years, with the possibility of extending the fiscal adjustment period to 7 to allow the execution of strategic investments and reforms. And due to the very nature of the agreement, and given that many of the reforms already made for the Next Generation can be taken into account, it is practically guaranteed that anyone who is in imbalance will be able to schedule it throughout those seven years.

Although it persists in the framework of potential GDP, one of the great obsessions for countries like Spain, which complain that indirect observations do not serve to reflect the real picture of the state of an economy, the central axis from now on will be a single indicator for the entire adjustment period, the spending path for each country, collecting possible accumulated deviations in a “control account”.

Two different cases must be distinguished. On the one hand there are the countries in Excessive Deficit Procedure, that is, those that the Commission puts in the corrective arm due to their imbalances. These will have to continue making an effort of 0.5% in structural terms. The novelty of the system, compared to the previous one, is that the Commission, when deciding how much effort should be made, will take into account increases in debt interest. And that will help soften and give each country room for investment. Each Government will be able to gain up to 0.2% flexibility. It does not mean that you will be ‘forgiven’, because the adjustment will have to be made at some point, but it will not have to be done immediately, but rather a few years later, allowing the investment not to be sacrificed, as always happens in a crisis.

The second case is that of the so-called preventive arm, that is, the countries that are not in an excessive deficit procedure (EDP) but that have to continue with consolidation. When the country manages to leave the EDP, another regulation will be applied. The Commission will carry out an analysis of the sustainability of the Debt and will calculate the level of effort necessary for the debt to be reduced to 1% annually and the deficit to progressively fall to 1.5%, the new comfort margin.

But there will only be one figure. The Commission will calculate what effort must be made for those three mentioned criteria and that will set the level of effort required for the next four or seven years. And the only way to measure it will be the spending path. It will not be how much the debt itself decreases each year, but rather whether the spending control rule set for that medium-term trajectory is met. There the simplification compared to the previous system.

In the last hours, the Spanish presidency presented a final compromise proposal, after collecting what Paris and Berlin debated last night. And ministers have given the go-ahead, despite their reservations. Thus, all those who have a debt of between 60% and 90% of GDP, that is, above the maximum of the Stability Pact, will have to guarantee an effective average annual reduction of half a percentage point. And those that have more than 90%, like Spain, will have to go down at least 1%. Much less than the 1/20 stipulated in the previous framework, but in any case a measure that was not in the Commission’s original proposal.

Likewise, the agreement contemplates that there will be a structural deficit fiscal margin of 1.5% of GDP, below 3% in the preventive arm. That is, even those who have healthy accounts will have to continue making notable efforts, so that 3% is never the final objective, as many countries were now, but rather a maximum to be avoided. That way, when there is an unexpected shock, and the countries’ automatic stabilizers are activated, triggering public spending, it will not automatically go to the corrective arm.

The concern of countries like Spain, but especially France, was the speed of adjustment of the structural deficit and its composition. Thus, the reduction of the primary deficit for countries in the preventive arm, that is, below a 3% deficit, will ultimately be 0.4% of GDP per year (and not 0.5% as the orthodox preferred), which may even be reduced to 0.25% in the case of an extension from 4 to 7 years in the path, as explained by the Ministry of Economy. An attempt to maintain investments and reforms.

The word primary, that is, without taking into account the interest on the debt, is key in this aspect, because Paris, Rome or Athens, the most indebted in the EU, wanted it to be that way, despite the very tough Nordic and European opposition. the frugal ones. That this is so is striking. And even more so taking into account that the rules contemplate, also by French demand, which considered that sufficient German demands had already been accepted, a transitional regime until 2027 that softens the impact of the increase in the debt interest burden, protecting and preserving investment capacity. Two last-minute transfers, relevant, but pale in comparison to the army of safeguards that the liberal German finance minister has achieved with his firm opposition.

“I am glad that, after a long debate and tough negotiations, we have reached a good agreement on EU tax rules. It is important that these rules provide a solid basis for national budgets and that they are respected by everyone. This has a positive impact on the common interest of all Member States. For the Netherlands, it is key that with this agreement we move towards an ambitious and sustainable debt reduction. This agreement establishes fiscal rules that encourage reforms, with room for investments and adapted to the specific situation of the Member State in question and in a counter-cyclical manner, so that potential economic growth is not truncated. There is a need to better respect the rules, something that has too often been a problem in the past,” said Dutch Minister Sigrid Kaag. , which breaking with years of confrontations, laid the philosophical foundations of what has ended up being the proposal in a hand-in-hand paper with the Spanish Nadia Calviño.

“Today’s political agreement on the reform of EU tax rules has been a long time in the making. After many months of hard work, especially by the Spanish Presidency, this is a real breakthrough. Once this agreement is reached formalized into a general approach, which should happen very soon, negotiations with the European Parliament can begin so that EU Member States have clarity and predictability in their tax policies for the coming years. Time is of the essence if they are to adopt these new rules before next year’s European elections. They will allow us to preserve the sustainability of public finances, provide space for investment and incentivize reforms. At a time of significant economic and geopolitical challenges, there is no time to waste,” he recalled Vice President Valdis Dombrovskis.

“While the negotiations have added some complexity to the texts compared to our proposal, they preserve their central elements: a move towards greater medium-term fiscal planning; greater ownership by Member States of fiscal plans, within a common framework; and the possibility of applying more gradual fiscal adjustment to reflect investment and reform commitments. This journey is not over yet. I am confident that the same spirit of constructive engagement that has brought us today’s successful outcome will take us to a positive conclusion of the final steps of this process and to the entry into force of this crucial reform in the spring of 2024”, added the Commissioner for Economic Affairs, Paolo Gentiloni.