Why EU’s Budget Rules Invite Members to Test Limits

(Bloomberg) -- The European Union requires all 28 member nations to maintain sound public finances, no matter their size or national challenges. But infractions generally don’t result in real punishment, and smaller countries sometimes complain that the biggest economies have gotten the most leniency. That’s set up a perpetual push and pull between the EU and national governments who test the limits, the way Italy did last year. While Brussels dares do little to enforce the rules, the stigma of being a fiscal pariah is often enough to rattle financial markets and push reprobate countries into discipline.

1. What are the EU budget rules?

They state that no country should have a budget deficit larger than 3 percent of gross domestic product or debt above 60 percent of output. Failing that, governments must set annual targets to show they’re moving in the right direction. The European Commission, the EU’s executive arm, monitors the finances of the bloc’s members, reviews annual spending plans, identifies imbalances and issues country recommendations every spring. These have to be endorsed by finance ministers and incorporated into budget plans for the subsequent year.

2. Are there consequences for breaking them?

The 19 EU members that use the common euro currency can be fined as much as 0.5 percent of gross domestic product for consistently flouting the rules, though that’s never happened. Countries that keep their national currency, like Hungary and Sweden, can’t face financial penalties, though the commission could freeze some EU funds to them. Since 2013, euro-area countries -- plus Bulgaria, Denmark and Romania -- are also required to pursue a balanced budget by law. It’s a step aimed at keeping mounting public debt in check after the European sovereign debt crisis brought countries like Greece and Portugal to the brink of collapse.

3. What gives the EU this power?

The fiscal rules are set out in what’s called the Stability and Growth Pact, an agreement struck in 1997 by the bloc’s members to maintain the steadiness of the economic and monetary union. While monetary policy for the euro area is the responsibility of the European Central Bank, and matters such as taxation are up to each country, the EU expects its members to heed the economic stability of the region as a whole. The limits were originally set out in the Maastricht Treaty.

4. Who has tested the limits?

France, Belgium and Spain are among the many countries that have received warnings or reprimands from the EU in recent years, though never a formal rejection of their draft budget or any financial sanctions. The EU opted not to penalize repeat offenders Spain and Portugal in 2016. France may breach the rules again after President Emmanuel Macron promised a costly household stimulus package in response to the Yellow Vests protests. In October, Italy was the first country to receive an outright rejection of its spending plans from Brussels during a weeks-long standoff that rocked financial markets. Italy’s populist leaders Matteo Salvini and Luigi Di Maio long insisted they wouldn’t budge on expensive electoral promises of a lower retirement age and a citizen’s income for the poor.

5. Why aren’t rule-breakers punished more?

It’s political. Ultimately sanctioning a country requires a long process that proves a persistent defiance of the bloc’s rules. In the past, the EU has opted instead to give countries like France more time to meet their targets, or even set symbolic “zero” sanctions like in the case of Spain and Portugal, when it feared fanning anti-EU sentiment across the bloc. Euro-area members submit draft budget plans to Brussels every October, so the commission can issue an opinion on whether they’re in line with the rules. Governments are expected to take the feedback into account before voting a budget through their national parliaments by the end of the year. Usually this back and forth leads to an agreement that’s deemed acceptable for that situation.

6. How was Italy’s budget spat resolved?

Deputy Prime Ministers Salvini and Di Maio finally agreed to delay and dilute their landmark election pledges under pressure from the country’s prime minister and finance minister. Rome lowered its deficit target for 2019 to 2.04 percent from a previous 2.4 percent, which the EU had rejected as an “unprecedented” breach of the bloc’s rules. In the end, the commission held off on a disciplining procedure that could have led to fines. But Brussels has warned it will continue to monitor the performance of Italy, which has the euro area’s biggest debt mountain in real terms.

7. Is Greece still in trouble?

No. Greece recently had different budget targets altogether. From 2010 to 2018, when it received rescue loans from the euro area and the International Monetary Fund, it wasn’t subject to the EU’s normal budget monitoring process. Under successive bailouts, the country had different objectives to reduce its outsize deficit, while its debt ratio ballooned to over 180 percent of output despite being restructured several times. Now that the country is out of its creditors’ purview, its spending plans are in line with EU rules. Its budget is in surplus, while its spending is kept at levels agreed in a debt relief deal struck at the end of its bailout.

8. What’s France’s situation now?

As the Yellow Vests protests spiraled into widespread anger over the cost of living, Macron’s government announced spending measures that added 0.5 percentage points to the 2019 deficit, bringing it to 3.4 percent of GDP -- above the EU’s limit. At the same time, French officials pledged their commitment to economic reforms. To avoid fanning tensions, the EU said the bloc will examine France’s spending again in the spring. This sparked renewed complaints from Italy that it’s treated differently from France.

9. Do European voters care about the rules?

It depends where, but in general, not currently. For example, in Portugal, which recently came out of the EU’s disciplinary arm on budgets, people largely agree that fiscal restraint is a good thing. In Hungary, the Czech Republic and Poland, anger is focused on the EU’s threats to punish members financially for veering away from the bloc’s democratic norms, rather than the budget rules. During Italy’s budget battle, Salvini portrayed himself as a champion of national forces seeking to wrest control from Brussels Eurocrats. It was a theme calculated to resonate across the Continent ahead of the European Parliament election in May. Whether it does remains to be seen.

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