�ԹϺ�����

The long-awaited – the set of rules designed to ensure that debt in one country doesn’t drag down the rest – seems to be heading towards agreement. EU finance ministers will on 19 December to close the deal. 

But will it be a good deal? Negotiations on the reform, in April 2023, focused initially on the so-called preventive arm of the framework. According to the Commission’s proposal, governments would be required to put public debt “on a plausibly downward path” by the end of a four to seven-year adjustment period or keep it below 60% of GDP and bring or maintain government deficits below 3% of GDP over the same period. The main dispute between countries has been whether these requirements should be complemented by ‘safeguards’ – simple quantitative rules requiring minimum debt and/or deficit reductions – and how such safeguards should be designed. 

Disagreements on these matters have narrowed. The main outstanding issue is now the framework’s excessive deficit procedure (EDP). This requires countries with deficits above 3% of GDP to reduce their deficits by at least 0.5% of GDP per year. The question is exactly how the 0.5% deficit reduction is measured. The answer is important, because almost half of EU countries might end up in the EDP next year, and because some of their deficits are expected to be large (with those of France, Italy, Belgium, Hungary, Slovakia, Malta, Poland and Romania exceeding 4% of GDP). 

One group of countries, led by France, has wanted to exclude both interest payments and green investment expenditures from the calculation of the 0.5% adjustment minimum. This would make a big difference. France’s interest payments are projected to rise by 0.2%-0.3% of GDP per year as higher interest rates push up the average cost of borrowing. Like many other EU countries, it will need to raise green public investment by 0.5% to 1% of GDP in the next few years to meet green targets. Excluding these expenditure items would cut France’s annual fiscal adjustment substantially. As a result, it would also have lengthened the time needed to reduce the deficit to less than 3%.

This rang alarm bells for another group of countries, led by Germany. They worry that diluting the EDP would endanger the ability of the new system to ensure debt declines within a reasonable period. 

The deal that might be finalised on 19 December could be based on . This would lower the minimum adjustment under the EDP up to 2027, after which it would rise to the current level of 0.5%, including interest payments. It is a bad compromise because it does not tackle the core problem. 

The challenge for the EU is to satisfy two conditions simultaneously. 

First, the new framework’s debt-sustainability requirements should apply in the same way to all member states. As envisaged in the European Commission’s April proposal, the debt ratio should fall with high probability after four to seven years in all countries with debt above 60%, regardless of whether these countries are initially in the EDP or not.

Second, the timing and pace of the adjustment within the four to seven-year period should be sufficiently flexible to allow realistic annual adjustment targets and to give space to green investment. Such investment will benefit the entire EU. Because it continues to be mainly financed at national level, there is a high risk that countries will want to invest too little, rather than too much. As long as EU fiscal rules fulfil their main goal – to ensure debt sustainability – they should not constrain extra investment. But this is what the potential Franco-German compromise would do.

To achieve both objectives, member states should agree on the following on 19 December.

First, reaffirm and strengthen a rule that was part of the Commission’s April proposal, namely that the “corrective net expenditure path” under the EDP should be subject to the same debt-sustainability criteria as would be required in the preventive arm.

Second, express the annual minimum adjustment requirement under the EDP in the same units as adjustment in the preventive arm – that is, in ‘structural primary balance’ terms, which exclude interest and cyclical revenue changes. The adjustment requirement in the EDP is supposed to ensure a minimum fiscal effort. Including items that change for reasons that are mostly outside the control of governments would obfuscate the measurement of effort.

Third, exclude green investment spending from the calculation of the annual minimum adjustment effort under the EDP, provided that:

1. The green investment programme is approved by EU countries and monitored by the Commission, and
2. Total adjustment is high enough to bring the overall deficit below 3% and ensure a falling debt ratio, including any debt used to finance investment, after the adjustment period.

These principles would give EU members the flexibility to increase green investment temporarily to meet European Green Deal objectives without endangering fiscal sustainability. In years of high green investment, deficits could remain higher than would otherwise be permitted. Deficits might be allowed to increase in years in which investment increases, and debt might continue to rise for a few years, even in countries that are subject to the EDP. But by the end of the adjustment period, the overall deficit (including interest and investment spending) must be below 3%, and the primary balance must be high enough to meet all debt sustainability conditions.