EU Revamp Keeping 3% Deficit Rule Wins Southern Europe Convert

(Bloomberg) -- Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.

A reform proposal that would keep the European Union’s deficit limit to 3% of gross domestic product is getting traction in one crisis-scarred corner of southern Europe, namely Cyprus.   

The initiative in a paper by European Stability Mechanism officials would change the Stability and Growth Pact by raising the ceiling on debt to 100% of output, and putting a brake on spending growth while maintaining the rule for budget shortfalls. 

Read More: Lift Euro-Zone Debt Rule Limit to 100% of GDP, ESM Paper Says

“What is important is to remain disciplined regarding the deficit criteria, and there the ESM hasn’t suggested an increase in the 3% level,” Cyprus Finance Minister Constantinos Petrides said. “The ESM follows a more pragmatic approach at this time, because many countries are exceeding the 60% target also due to the pandemic.”

In a wide-ranging interview in Nicosia, the minister also shared his concerns about inflation in the euro region, saying that if price increases prove less short-lived than currently predicted, they could prompt interest-rate hikes in the medium term.  

Petrides spoke little more than a week since the EU began a consultation on the future of its deficit regime, starting what is likely to be a controversial process pitting fiscally frugal northern countries against indebted southern members. The current rules are deemed by many economists to be too much of a straitjacket hindering growth.   

The reaction from Cyprus, which suffered its own turmoil during the euro-zone sovereign debt crisis of the past decade, hints at a diversity of opinion even in southern Europe. 

Italian Prime Minister Mario Draghi has deemed the pact “obsolete,” though his actions so far suggest the focus of his disdain is the deficit rule, which his government’s own projections don’t envisage a return to for the foreseeable future. 

Battle Lines 

The proposal in the ESM paper published this week is just one idea thrown into the mix for the EU’s 27 members to chew over. In an early sign of battle lines forming, last month Austria led what it described as a “coalition of responsibility” with seven other countries that together called for any changes to the pact to be limited. 

Petrides favors a higher debt ceiling because “huge public investments will be needed to materialize the green deal” pushed by the EU to make its economy more environmentally sustainable. The deficit rule remains sensible for him. 

“For Cyprus this is very important,” he said. “In safeguarding our public finances, we are safeguarding the credibility of the Cyprus economy and the investment grades.”

Petrides is currently projecting debt to fall to 107% of output this year and to below 100% in 2022. At the peak of the pandemic, it reached 119.1%.  

The finance minister, who once worked as an economist at the European Commission, said that while the surge in consumer prices in Europe is mainly due to short-term external phenomena such as supply-chain disruptions, stimulus plays a role. 

“The very expansionist monetary and fiscal policy that we follow in Europe, but also in most developed economies, is also creating a part of this,” he said. “Having expansionary policies for a long time that sometimes don’t abide with the philosophy of the economic cycle can create disruptions like inflation, so we have to be careful.”

Rate View

Just two days before an interest-rate decision by the ECB, Petrides observed that the institution’s policy of keeping borrowing costs at ultra-low levels may be time-limited. 

“I would expect in the medium term to perhaps see an increase in the interest rates, if inflation persists and isn’t so short-term,” he said. 

Cyprus is pursuing a new investment plan to attract foreign companies and staff that offers the possibility that the could become a “hub for international enterprises and organizations” the minister said. 

The initiative focuses on shipping, pharmaceutical and information technology companies that have already helped Cyprus to diversify following the end of its passport-for-investment program and a pandemic-induced slump in tourism. 

“The prospect of expansion in this area is great,” Petrides said. “The IT sector has the prospect of a significant contribution to GDP that’s much higher than traditional sectors.” 

©2021 Bloomberg L.P.