Brussels makes overture to Berlin with new EU rules to cut down deficit

The debate on how to adapt the European Union’s long-standing fiscal rules to the economic reality that has emerged from successive crises entered a new chapter on Wednesday, as the European Commission unveiled a series of much-anticipated legislative proposals that featured several elements meant to allay the concerns of one particular country: Germany.

As part of the revision, Brussels has added a safeguard that will compel member states with deficits exceeding 3% of gross domestic product (GDP) to make adjustments worth at least 0.5% of their GDP every year until they fall back in line.

According to 2022 data, countries like Italy, Hungary, Romania, Malta, Spain and France are the likeliest to fall under the corrective mechanism.

Germany had previously requested minimum targets to ensure a sufficient debt reduction on an annual basis, going as far as suggesting a 1% rate for highly indebted states. The Netherlands, another country known for advocating prudent spending, has also called for similar benchmarks, but without specifying the numerical range.

Although the Commission’s proposal does not go as far as what Germany might have expected, it does represent a notable deviation from a preliminary report released in November, in which the executive outright rejected any sort of one-size-fits-all approach to debt reduction.

“We have listened to the views of different member states, we have listened to the European Parliament, to social partners, to different stakeholders,” said Valdis Dombrovskis, the European Commission’s executive vice president, while presenting the proposals.

“What we’re putting forward we believe is a balanced package that takes all those different inputs into account.”

Speaking by his side, Paolo Gentiloni, the European Commissioner for economy, said the draft texts would help “build a consensus to bridge” existing disagreements and urged co-legislators to wrap up discussions by the end of the year.

But the overture failed to win over Berlin: shortly after the presentation, German Finance Minister Christian Lindner delivered his personal rebuke.

“The proposals of the European Commission do not yet meet the requirements of Germany,” Lindner said in a short statement.

“We work in a constructive way but no one should be under the misunderstanding that Germany will automatically consent to the proposals. We will only agree to rules that enable a reliable path to lower debts and stable public finances.”

A spokesperson for the Dutch government issued a more moderate reaction and underlined the revised rules should lead to “ambitious debt reduction” as well as “better compliance and enforcement.”

Under existing rules, all EU governments are required to keep their budget deficits below 3% of gross domestic product (GDP) and their public debt levels below 60% in relation to GDP, thresholds that many countries exceed after years of intense spending to cushion the impact of the COVID-19 pandemic, Russia’s war in Ukraine and exceptionally high energy prices.

In the last quarter of 2022, debt across the bloc stood at 84% but was much higher in countries like Greece, Italy and Portugal.

The enforcement of the fiscal rules has been suspended since the onset of the coronavirus and is scheduled to be reactivated in 2024 under a revised form.

While the Commission is intent on maintaining both the 3% and the 60% objectives, it considers the overall framework to be obsolete and out of touch with the shifting economic landscape and the transition towards a climate-neutral society.

The reform designed by the executive envisions greater ownership and flexibility for governments, who will now be asked to design their own mid-term fiscal plans to bring debt back to sustainable levels. The country-specific blueprints will be negotiated between each capital and the Commission and later approved by the EU Council, following the model of the COVID-19 recovery fund.

The fiscal adjustments necessary to meet – or at least head towards – the 3% and 60% targets will be carried out over a period of four years, extendable to seven in exchange for further reforms.

But this renewed focus on national characteristics has caused concern in some countries, including Germany and the Netherlands, who fear non-compliant governments will enjoy too much discretion in how they sanitise their public finances.

The Commission has now picked up the slack and introduced four safeguards to guarantee what Dombrovskis called “transparency and equal treatment” among the 27 member states.

Countries whose deficit exceeds 3% of GDP will need to make annual adjustments worth 0.5% of GDP until the deficit falls below the mark.The debt-to-GDP ratio must be visibly lower at the end of the four-year plan.In case the plan is extended to seven years, the majority of the fiscal corrections should take place in the first four years, rather than being delayed to the very end.Net expenditure must always remain below potential economic growth.

Additionally, any country that strays from the mid-term plan agreed with the Commission will be automatically subject to a so-called Excessive Deficit Procedure (EDP), which can eventually lead to financial sanctions.

“No heel-dragging, no backloading: member states will not be allowed to push back fiscal adjustments to a later date,” Dombrovskis said.

Brussels will expect countries to meticulously abide by the terms laid out in the mid-term plan, even if the government changes priorities after an election. There will be, however, a possibility of negotiating an amendment to take into account new economic circumstances.

Only in extreme cases of hardship or disruption will the Commission trigger the escape clause to suspend the enforcement of the fiscal rules, as was the case during the COVID-19 pandemic.

The bundle of legislative proposals unveiled on Wednesday still needs to be discussed by member states and the European Parliament, a process that is poised to be heated and divisive.

Nils Redeker, deputy director at the Berlin office of the Jacques Delors Centre, said the safeguards designed by Brussels were a “reasonable offer” and “clearly an attempt to get Germany on board” but were not as tough as what Berlin had demanded.

“They provide the basis for negotiations to come and, of course, some member states will be very unhappy with this,” Redeker told Euronews.

“In the end, it will depend on the landing zone for the benchmarks that we have now on the table. I’m not sure the 0.5% will survive negotiations.”