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Ukraine war blurs Brussels’ plans to reapply debt, deficit rules

Brussels may keep the EU’s rules for public spending on ice for another year given that the fog of war has clouded Europe’s economic outlook, Commission officials hinted on Wednesday.

The Commission is signaling its readiness to put the brakes on reintroducing its fiscal governance framework from next January on in a so-called fiscal guidance to EU treasuries. But even before the war broke out, there were signs that the rules won’t be enforced too strictly and result in excessively harsh austerity policies — provided governments still rein in deficit spending.

The policy guide is designed to help finance ministers formulate their budgets for 2023, when the so-called Stability and Growth Pact was supposed to come back into force. Russia’s invasion of Ukraine has muddied those plans. The attack has already had an impact on energy prices, pushing initial estimates on inflation for February to a record high of 5.8 percent.

Then there’s the outlook for growth. Prior to war, the Commission had already downgraded its growth forecast for this year to 4 percent after the spread of Omicron forced some countries to reintroduce containment measures.

Those growth figures are now unclear. The next economic forecast from the Commission is due in late May, when it’ll decide whether the SGP’s reintroduction should be reassessed “in view of the high uncertainty,” the document said.

“Ukraine will likely impact EU growth negatively, including through repercussions on financial markets, further energy price pressures, more persistent supply-chain bottlenecks and confidence effects,” Economy Commissioner Paolo Gentiloni told reporters after publishing the communiqué. “This combination will likely weigh significantly on the expected economic expansion in the EU but without derailing it.”

The EU paused the SGP rules, which cap budget deficits at 3 percent of economic output and try to limit public debt at 60 percent, at the start of the pandemic. Until that pause, the framework required countries with debt levels above that threshold to reduce the difference at a rate of 5 percent a year.

The Commission justified its freeze of the rules by arguing capitals should be able to battle the spread of the coronavirus and cushion the economic fallout without fear of reproach. But loosening the purse strings has had an effect on the bloc’s debt levels, especially in the South, where governments have long grappled with a sluggish recovery from the financial meltdown of 2008 and the following sovereign debt crisis.

As a result, EU debt levels are still well above the SGP thresholds. They reached 92 percent of economic output in 2021 and are expected to fall slightly to 89 percent in 2023. As of the end of September, Belgium, Cyprus, France, Greece, Italy, Spain and Portugal all had debt piles above 109 percent.

Light-touch approach

Heavily indebted countries, however, won’t have to worry too much if the EU’s executive decides to go ahead with reapplying the rules from 2023. The Commission has already signaled that reinforcing the rules to the letter would be self-destructive, especially when considering the amount of investment needed to combat climate change this decade.

Accordingly, countries should either respect the deficit threshold or explain how they plan to bring their rate of spending under control, the Commission noted. But “compliance with the debt reduction benchmark would imply a too demanding frontloaded fiscal effort that risks [jeopardizing] growth,” the document said. 

The Commission will also hold back from opening any excessive deficit procedures (EDP) for the time being — a red-flag label for countries in breach of the EU’s budget deficit rules. This could change in the fall, the guidance said, to sway any governments that might take advantage of the Commission’s leniency. That said, the EU isn’t ready to blindly follow the SGP in any case.

“National fiscal strategies should reflect each country’s individual circumstances,” Executive Vice President Valdis Dombrovskis said at the press conference. “So, this is not a one-size-fits-all concept.”

This story has been updated.

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