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The EU has agreed a much-delayed reform of its fiscal rules, in a move that economists say will usher in an era of tighter budgets, even as European growth prospects are set to weaken.
After weeks of haggling, EU negotiators on behalf of governments and the European parliament on Saturday agreed to set annual targets for cutting public debt and limits for public spending — a key German demand.
The compromise gives treasuries more room for public investments by allowing countries to bring down excess debt at a slower pace over four to seven years. Also, in a nod to France and Italy, a number of exemptions allow for a more gradual tightening of the public purse.
The deal comes after the so-called Stability and Growth Pact that limits public deficits to 3 per cent of gross domestic product and national debt at 60 per cent of GDP was suspended over the past four years to allow countries to rebound from the pandemic and cushion the impact of Russia’s invasion of Ukraine — with debt and deficits ballooning across the bloc.
Economists concur that the reformed fiscal rules will lead governments to progressively rein in spending, affecting the region’s struggling economy.
After expanding at a tepid rate of 0.5 per cent in 2023, the eurozone is set to grow 0.8 per cent this year, according to the European Central Bank. The European Commission is likely to revise its own growth estimates for 2024 downward next week.
Dani Stoilova, an economist at French bank BNP Paribas, estimated that the new fiscal requirements would knock about 0.1 to 0.2 percentage points off GDP over the next two years.
Spain, the eurozone’s fourth-largest economy, would have to do the most extra fiscal tightening among the bloc’s biggest members under the new rules, reducing its structural primary deficit by an extra 1 percentage point of GDP more than planned in 2025, according to an estimate by BNP Paribas.
The rules will have little impact on Germany, the biggest economy in Europe, where a recent constitutional court ruling on national budgetary rules forced the government to reduce its planned spending even further.
France has not managed to achieve a surplus in its primary budget that excludes interest costs since 2008 and rating agency S&P Global this week forecast that on this measure its deficit would remain one of the biggest in the eurozone over the next three years. Morgan Stanley estimated recently that France was the least likely of the four biggest eurozone economies to meet the targets set under the new rules.
Italy, which has the highest debt burden among major eurozone economies, will also struggle to reduce it, according to Morgan Stanley economists.
“Italy has historically posted primary surpluses but its ability to achieve the required adjustment is not a given, in a context where it has to pay high interest expenses,” they wrote recently in a note to clients.
Overall, the consensus view is that the rules are more demanding than the status quo, but more lax than the former framework that was suspended in 2020, and which was not consistently enforced.
“The risk with the new rules is that they will fall flat at the first hurdle, compelling a level of fiscal adjustment that is counter-productive given the growth and strategic challenges the EU is facing,” said Mujtaba Rahman, managing director for Europe at Eurasia Group.
A lot will hinge on the degree of flexibility with which the commission will apply the new rules, which will apply from 2025.
“This final agreement is not the pact of my dreams, it is different from the commission proposals, especially because it is a lot more complicated,” said EU economy commissioner Paolo Gentiloni, whose original proposal was the basis for the final framework.
“But when we take this decision, we should be very serious about the fact that we have to implement it and enforce it.”
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