Commission proposes sweeping reforms of EU fiscal rules

The European Commission has proposed sweeping reforms of the EU's fiscal rules when they are reinstated next year, after they were suspended during the Covid pandemic.

The reforms are designed to give national governments more "ownership" of debt reduction plans and to make them more manageable, while encouraging investment and reform.

However, Germany and other fiscally hawkish member states have warned the plans will weaken debt and deficit rules.

The Commission says the new rules will be simpler, more flexible and will have more effective enforcement.

"We are living in a very different world to 30 years ago [when the rules were adopted]: different challenges, different priorities," said Valdis Dombrovskis, an executive vice-president of the European Commission.

Under the EU’s Stability and Growth Pact (SGP) member states have been required to maintain deficit levels at below 3% of GDP, and debt levels at below 60%.

The rules were effectively suspended when the pandemic hit, as countries raced to spend money on shoring up economies during the crisis which followed.

With the EU facing huge spending challenges on meeting its climate goals, digitalising its economy and coping with Russia’s invasion of Ukraine - meaning increased defence spending - a consensus emerged that the existing rules would need to be made more flexible to allow for strategic public spending.

The Commission’s proposals follow a review of the SGP which was underway even before the pandemic struck.

Under the old one-size-fits-all rules, member states were required to cut debt levels by 1/20th per year in order to reach the target of 60% of GDP, or face penalties.

With debt levels climbing during the pandemic, such rigid targets have been seen as unrealistic.

Greece’s debt level stood at 185% of GDP at the end of last year, while Italy’s stood at 141% (Ireland’s debt to GDP ratio fell to 46.5% in 2022).

The new proposals foresee the targets of 3% deficit and 60% debt levels remaining in place, but with the Commission striking bilateral deals with member states on tailored debt-reduction paths, ensuring they have enough time to reduce debt levels while allowing scope for investing in the green transition or defence spending.

Member states would have to reduce debt by 0.5 percentage points of GDP per year if debt limits were breached, and debt would have to be reduced within a four year horizon.

Spending would have to be kept below potential GDP growth, but there is no set rule by how much.

Officials say the new rules will allow for an extension of the four year time frame to reduce debt so long as there are structural reforms as well as investment in productivity growth, the green transition, defence spending and so on.

Germany has already been lobbying hard to maintain strict debt reduction rules.

Writing in the Financial Times, the German finance minister Christian Lindner warned that a bilateral negotiation between the Commission and a national capital on reducing debt would become a political discussion.

He said the Commission's plans, as they were initially floated last November, "do not yet sufficiently define clear requirements for reducing deficits and debt ratios or keeping them at sufficiently low levels."

Member states and the European Parliament will debate the plans over the next year, with the Commission expecting them to be adopted before the European elections in June 2024.