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Economic governance package (1): Strengthening the Stability and Growth Pact

29 September 2010
by eub2 -- last modified 29 September 2010

The European Commission has today adopted a legislative package containing the most comprehensive reinforcement of economic governance in the EU and the euro area since the launch of the Economic and Monetary Union. Broader and enhanced surveillance of fiscal policies, but also macroeconomic policies and structural reforms is sought in the light of the shortcomings of the existing legislation. New enforcement mechanisms are foreseen for non-compliant Member States. The recently agreed "European semester" will integrate all revised and new surveillance processes into a comprehensive and effective economic policy framework.


An overview of the package and its objectives

The different strands of economic policy coordination are to be integrated in a new surveillance cycle, the European Semester. This will bring together the existing processes under the Stability and Growth Pact (SGP) and the Broad Economic Guidelines, including through simultaneous submission of the stability and convergence programmes and the national reform programmes.

The legal instruments proposed in the legislative package adopted today by the Commission cover three main subjects:

First, the Commission proposes to reinforce EU Member States' compliance with the Stability and Growth Pact (SGP) and to deepen fiscal policy coordination. Excessive debt must be addressed more seriously than in the past. Fiscal responsibility is encouraged by setting minimum requirements for national fiscal frameworks to make sure they are in line with EU Treaty obligations.

Second, the Commission proposes to broaden economic surveillance to prevent, detect and correct macroeconomic imbalances and divergences in competitiveness. This proposal is designed to tackle intra-EU and especially intra-euro-area imbalances in a preventive and effective way. In practical terms, this means creating a scoreboard of economic and financial indicators and carrying out in-depth country analyses. When necessary, country-specific recommendations will be addressed. Euro area members who show insufficient compliance with their respective recommendations could also face sanctions.

The third element of these proposals aims at strengthening of the enforcement mechanisms. Effective, timely and fairly applied enforcement mechanisms are crucial for the functioning of the economic surveillance framework. This requires the introduction of a wider range of sanctions and incentives, which would be applied gradually, and at an earlier stage of the surveillance process than is currently the case.

Fiscal surveillance: strengthening the Stability and Growth Pact (SGP)

The key instrument for fiscal policy co-ordination and surveillance is the Stability and Growth Pact (SGP), which implements the Treaty provisions in the area of budgetary discipline. Strengthening the Pact is important for increasing the credibility of the agreed coordinated fiscal exit strategy.

In its Communications of 30 June 2010, the Commission announced the intention to present legislative proposals aimed at strengthening the Pact by: i) improving its provisions in the light of the experience, notably of the crisis; ii) equipping it with more effective enforcement instruments; and iii) complementing it with provisions on national fiscal frameworks.

The SGP consists of two arms: one on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies (the so-called preventive arm, based on Article 121 of the Treaty) and one on the implementation of the excessive deficit procedure (the so-called corrective arm, based on Article 126 of the Treaty). The SGP underwent a reform in 2005. The proposals outlined here represent a further evolution.

This is further complemented by a new set of enforcement instruments for the euro area, established on the basis on Article 136 of the Treaty, which allows for measures strengthening the coordination of economic policies among euro-area Member States, notably in the area of budgetary discipline.

Finally, the requirements for budgetary frameworks of the Member States are the subject of a draft directive based on Art. 126 of the Treaty and aiming at specifying the provisions of the Treaty Protocol on the excessive deficit procedure concerning national budgetary procedures.

The preventive arm of the SGP is meant to ensure that Member States follow prudent fiscal policies, so as to not put fiscal sustainability at risk with potential negative consequences for EMU as a whole.

Generally insufficient progress towards medium-term budgetary objectives (MTO) has left public finances badly exposed to the economic downturn. Even apparently sound budgetary positions before the crisis masked in a number of countries strong reliance on windfall revenues to finance expenditure, the reversal of which contributed to soaring budget deficits.

To respond to these shortcomings, Commission proposes that annual expenditure growth should not exceed a prudent medium-term rate of growth of GDP, unless the MTO has been attained or the excess is compensated by measures on the revenue side. The essential aim is that to prevent that revenue windfalls are spent rather than being allocated to debt reduction.

Failure to respect the agreed principle will make the concerned Member State liable to a warning from the Commission and, in case of a persistent and/or particularly serious infraction, a Council recommendation to take corrective action, on the basis of Article 121 of the Treaty.

For euro area members, such a recommendation would be backed by an enforcement mechanism, based on Art. 136 of the Treaty, in the form of an interest-bearing deposit amounting to 0.2% of GDP.

A procedure of 'reverse voting' mechanism is foreseen for the imposition of the deposit: on proposal by the Commission, the deposit would become due on the issuance of the recommendation by the Council, unless the Council within ten days decides the contrary by qualified majority. The Council could reduce the amount of the deposit only on the basis of a Commission proposal and a reasoned request from the Member State concerned. The deposit would be returned with accrued interest once the Council considers that the deviation is corrected.

The corrective arm of the SGP is meant to correct deviations in budgetary policies which may put at risk the sustainability of public finances and potentially endanger the EMU. Member States are obliged to avoid excessive government deficits (3% of GDP) and debt (60% of GDP or sufficiently declining toward it). The excessive deficit procedure (EDP) currently foresees a sequence of steps, which, for euro-area countries, include the eventual imposition of financial sanctions.

The EDP has been regularly applied, even against the background of the exceptional circumstances of the financial crisis. However a number of shortcomings have emerged. While the deficit and the debt criterion were on an equal footing, in practice the 3% of GDP threshold has been the nearly exclusive focus of the EDP, with the debt playing so far a marginal role.

The existing EDP is backed in principle by a strong enforcement mechanism, as financial sanctions can, and should be, imposed in case of persistent failure to correct an excessive deficit. However, such sanctions arguably come into play too late in the process to represent an effective deterrent against gross fiscal policy errors, not least because the financial situation of the concerned country may be so deteriorated to make the threat of a fine less credible or counter-productive.

To respond to these shortcomings, Commission proposes to reform the corrective arm as follows.

The debt criterion of the EDP is to be made operational, notably through the adoption of a numerical benchmark to gauge whether the debt ratio is sufficiently diminishing toward the 60% of GDP threshold. Specifically, a debt-to-GDP ratio above 60% is to be considered sufficiently diminishing if its distance with respect to the 60% of GDP reference value has reduced over the previous three years at a rate of the order of one-twentieth per year. If that is not the case, the decision to place a country in excessive deficit would by no means be automatic and still take into account all relevant factors, such as whether very low nominal growth is hampering debt reduction as well as risk factors linked to the structure of debt, private sector indebtedness and implicit liabilities related to ageing.

Enforcement is strengthened by introducing a 'reverse voting' mechanism as well as a new set of financial sanctions for euro-area Member States, which would apply much earlier in the process according to a graduated approach.

A non-interest bearing deposit amounting to 0.2% of GDP would apply upon the decision of placing a country in excessive deficit. This would be converted into a fine in case of non-compliance with the initial recommendation to correct the deficit. The amount of the fine is equal to the sanctions already foreseen in the final step of the EDP. It also bears a link with the minimum amount that Member States currently receive in annual commitments from a relevant subset of EU expenditure categories. This should facilitate the eventual move to a system of enforcement linked to the EU budget as outlined in the above-mentioned Commission communication of 30 June 2010.

Further non-compliance would result in an increase of the fine, in line with the already existing provisions in the SGP.

To reduce discretion in the enforcement, the procedure of 'reverse voting' mechanism is foreseen for the imposition of the new sanctions in connection with the successive steps of the EDP. In concrete terms, upon each step of the EDP, the Commission will make a proposal for the relevant sanction, and this will be considered adopted unless the Council within ten days decides against it by qualified majority. The size of the non-interest bearing deposit or the fine can only be reduced by the Council on the basis of a specific proposal of the Commission following a reasoned request by the Member State concerned.

Moreover, the Commission proposal clarifies the criteria for assessing compliance with the recommendations at each step, including the possibility to allow an extension of the deadlines for the correction of the excessive deficit, by placing explicit emphasis on the fiscal variables that can be assumed to be under the direct control of the government, notably expenditure. Beyond these country-specific circumstances, the possibility of extending the deadlines is introduced also in case of a crisis threatening the smooth functioning of EMU.

National fiscal frameworks

Effective enforcement of the EMU budgetary coordination framework cannot be expected to derive only from provisions established at EU level. The objectives of the EMU budgetary coordination framework should be reflected in the national budgetary frameworks.

A national budgetary framework can be understood as the set of elements that form the basis of national fiscal governance. This includes public accounting systems, statistics, forecasting practices, numerical fiscal rules, independent national budget offices or institutions acting in the field of budgetary policy, budgetary procedures governing all stages of the budget process and medium term budgetary frameworks in particular, and fiscal relations across government layers.

The Commission today adopted a proposal of Directive on national budgetary to complement the reform of the SGP. The most fundamental elements of national budgetary frameworks, namely accounting and statistical issues as well as forecasting practices, should reflect minimum European standards to facilitate transparency and the monitoring of fiscal developments.

Domestic budgetary frameworks need also to adopt a multi-annual fiscal planning so as to ensure the achievement of the medium-term objectives set at EU level. Additionally, Member States must have in place numerical fiscal rules conducive to the respect of the deficit and debt thresholds. Member States must ensure that these features apply to all general government layers. National authorities must also guarantee the transparency of the budget process by providing detailed information on the existing extra-budgetary funds, tax expenditures and contingent liabilities.

Source: European Commission