FINANCE

Changes to EU debt, deficit limit unlikely

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Experts consider the chance of an agreement within the European Union on a rule change regarding the national debt level and budget deficit as exceptionally difficult in economic and political terms. Despite the temporary suspension of the ceiling of 60% of gross domestic product for the debt and 3% of GDP for the deficit, they are likely to remain intact.

Last week European Commission Vice President Valdis Dombrovskis made his opposition to any changes clear, pointing instead to modifications in the way debt is reduced, such as the rule for the annual reduction by 1/20th of the difference between debt levels and the 60% target.

The debate started from a proposal by European Stability Mechanism, International Monetary Fund and Bank of Greece economists for a rise in the debt ceiling to 100% of GDP.

Fabio Balboni, an HSBC economist, notes that “changing the 60% debt limit would be extremely unlikely. Similarly to the 3% deficit limit, this is enshrined in the EU Treaties and would require unanimity among countries, approval by the national parliaments – and in some cases even referendum – to be changed, which would be hard to achieve, particularly in the current political context.”

“The process of changing the rules is likely to prove lengthy. Northern European countries might seek certainty on the likely landing zone before opening the reform process, and Southern European countries will want reassurances that the new rule will contain as much flexibility as the previous ones,” notes Balboni.

Olivier Blanchard of the Peterson Institute for International Economics and former chief economist at the International Monetary Fund, tells Kathimerini that “it is important to put more weight on the deficit, less on the level of debt,” and that “in a low interest rate environment, debt service rather than debt is the main variable to focus on.”

He adds that “keeping the 1/20th rule would be a major mistake. I suspect that it may be hard to enforce, and may lead either to too contractionary a fiscal policy, or violations and another crisis about the rules. But in a low interest rate environment, debt service rather than debt is the main variable to focus on.”

Blanchard advocates fiscal standards instead of fiscal rules, that they should be country-specific assessments using a debt sustainability analysis methodology, and that higher levels of debt must be accepted, at least in the medium term.

Zsolt Darvas, senior fellow at the Brussels-based think tank Bruegel, says “the 60% of GDP public debt ceiling of European fiscal rules does not have a solid justification and looks too low from an economic perspective. Still, even after the pandemic recession and public debt increases, 13 EU countries are expected to have less than 60% public debt and six other countries below 80%, suggesting that it is not impossible to meet this target. The ESM proposes to change the ceiling to 100%, while the ESM does not propose to change the so-called 1/20th debt reduction rule (the gap over the ceiling has to be reduced by the 1/20th of the gap each year).”

“A problem with the 1/20th rule is that it is mechanical, does not consider economic circumstances the country faces. This rule was always disregarded in the past decade because countries violating this rule (Belgium and Italy) were assessed to implement structural reforms. I expect that about one-half of EU countries will violate the 1/20th rule from 2023. Yet, these violations can be disregarded again, because the European Commission assessed that all structural reform proposals of the recovery and resilience plans are great,” he tells Kathimerini.

“I see a meager chance of changing the 60% debt ceiling for economic and political reasons. Economically, it is difficult to set a single number that is right for every country. Politically, it would be difficult to change the protocol of the EU Treaty, which includes the 60% ceiling. But it is good that the ESM made a proposal because it stimulates a debate,” Darvas concludes.