The EU is tightening restrictions on member nations’ debt during an unfavourable economic climate.
The European Union (EU) is navigating a complex economic landscape characterised by rising debt levels among its member states. In response, the EU is tightening restrictions on national debt and implementing revised fiscal rules to ensure fiscal sustainability and promote responsible budgeting.
These changes have significant implications for member states, and they are occurring within a challenging economic context marked by the lingering effects of the COVID-19 pandemic, the energy crisis exacerbated by geopolitical tensions and inflationary pressures.
Background
The EU’s new fiscal framework, finalised in December 2023 and enforced starting in 2024, aims to ensure fiscal sustainability while allowing for flexibility in public spending. Key aspects of the new rules include deficit and debt targets, flexible adjustment paths, national medium-term plans, and the Excessive Deficit Procedure (EDP). Member states must maintain budget deficits below 3 per cent of GDP and public debt below 60 per cent. Countries exceeding these thresholds must implement corrective measures.
In April 2024, the European Parliament approved the revised fiscal rules to foster investment while ensuring that countries adhere to fiscal sustainability objectives. Key features of the new framework include minimum reduction requirements for countries with debt exceeding 90 per cent of GDP, flexibility in implementation, a focus on investments, and the requirement for national medium-term fiscal-structural plans.
In June 2024, the Commission proposed disciplinary measures for countries with high debts, signalling a shift towards stricter enforcement of fiscal rules. The revised fiscal rules require countries with debt exceeding 90 per cent of GDP to reduce their debt by an average of 1 per cent per year, while those with debt between 60 to 90 per cent must reduce it by 0.5 per cent annually. If a country’s deficit exceeds 3 per cent of GDP, it must be reduced during periods of economic growth.
The rules allow for extending the timeframe to achieve fiscal targets, providing more flexibility in managing economic fluctuations. Additionally, expenditures related to essential investments will be excluded from deficit calculations, encouraging member states to invest in growth-promoting projects without the immediate pressure of fiscal penalties.
Countries facing excessive deficits can reduce their deficits by 0.5 per cent annually, with more leniency for investments in defence, green initiatives, and digital transformation.
Each country must submit a medium-term structural fiscal plan that outlines how it will achieve compliance with the fiscal targets over four years, extendable to seven years based on specific reforms or investments. The EDP will be triggered if a country fails to meet the deficit or debt targets, leading to a required fiscal adjustment plan from the European Commission.
Analysis
The tightening of fiscal rules is expected to have significant implications for EU member states, particularly those with high debt levels. The requirement for annual debt reduction may strain national budgets, especially in countries already facing economic challenges. Nations like Italy and France, which are grappling with structural deficits, may find it difficult to balance the need for fiscal discipline with the necessity of funding essential public services and investments. Moreover, the emphasis on investment could lead to a shift in how governments prioritise spending. By allowing certain expenditures to be excluded from deficit calculations, member states may be encouraged to allocate resources towards infrastructure and innovation, potentially stimulating economic growth in the long term. However, this approach also raises concerns about the sustainability of public finances if investments do not yield expected returns.
The revised fiscal rules also strengthen the role of national independent fiscal institutions tasked with assessing the suitability of government budgets and fiscal projections. This enhancement aims to foster greater accountability and transparency in national budgeting processes, ensuring that member states adhere to their commitments while allowing for a more nuanced understanding of their economic situations.
The dialogue between member states and the European Commission is set to improve under the new framework. Countries facing difficulties meeting their fiscal targets can engage in discussions with the Commission to explore alternative paths, reflecting a more collaborative approach to fiscal governance within the EU.
Despite the potential benefits of the revised fiscal rules, significant challenges remain. The economic environment in the EU is still precarious, with inflation and energy costs continuing to pose risks to economic stability. Additionally, the political landscape in various member states may complicate the implementation of these rules. Governments may face pressure from domestic constituencies to prioritise social spending over fiscal discipline, leading to tensions between national priorities and EU mandates. Furthermore, the effectiveness of the new rules will largely depend on the willingness of member states to comply and the European Commission’s ability to enforce these regulations consistently. The balance between flexibility and accountability will be crucial in determining the success of the revised fiscal framework.
The EU’s decision to tighten restrictions on member nations’ debt is critical in its economic recovery. The emphasis on investment and flexibility in implementation may provide some relief, but the overarching need for fiscal discipline remains paramount. The success of these reforms will depend on the commitment of member states to adhere to their fiscal plans while balancing the need for growth and investment. The coming years will be pivotal in shaping the economic trajectory of the EU and its member states as they strive to achieve a sustainable and resilient economic future.
France, one of the countries most affected by the new fiscal rules, faces significant challenges. As of 2023, France’s deficit stood at 5.5 per cent of GDP, projected to remain at 5 per cent in 2025, while its debt was approximately 110.6 per cent of GDP, expected to rise to 113.8 per cent by 2025. These figures significantly exceed the EU’s thresholds, placing France under scrutiny from EU authorities.
Belgium’s deficit is projected to exceed the EU threshold, and like France, it will need to implement a medium-term fiscal plan. The country faces similar political pressures, with parties advocating for increased social spending, which may conflict with the need to reduce the deficit.
With a debt-to-GDP ratio of nearly 140 per cent, Italy is under significant pressure to comply with the new rules. The government must focus on structural reforms and potentially painful austerity measures to bring its deficit in line with EU targets, all while managing public discontent.
Hungary has been criticised for its fiscal policies, and the new rules require the government to adopt a cautious approach to spending. The political climate, marked by populist policies, may challenge compliance with the EU’s fiscal framework.
Malta’s economic growth has been robust, but it also faces the challenge of adhering to the new fiscal rules. The government must balance continued investment in growth with the requirement to reduce its deficit.
Poland’s government has committed to significant social spending, which could conflict with the fiscal targets set by the EU.
With its fiscal challenges, Slovakia will need to implement the new rules while addressing domestic demands for increased public spending. The government will have to navigate these pressures carefully to avoid triggering the EDP.
Assessment
- The EU’s new fiscal rules represent a significant shift in the management of member states’ budgets, particularly for France and the six other countries facing excessive deficits. While the rules aim to promote fiscal sustainability and allow for necessary investments, they also impose strict requirements that could lead to political and economic tensions.
- As these countries move forward, the effectiveness of the new fiscal framework will depend on their ability to implement sustainable fiscal policies that promote growth without compromising fiscal stability.
- The coming years will be critical in determining how these reforms shape the economic landscape of the EU and its member states.
