The European Commission said today that on balance, the first year of the application of the reformed Euro Stability and Growth Pact (SGP) is positive overall but more key tests are still ahead. The new Pact resulted in more national ownership of the budgetary discipline rules as a result of a stronger economic rational which ensures that economic differences between countries are better taken into account.

The Commission said that the consolidation efforts are more structural, durable and of quality. However, the assessment of the ‘preventive arm’ of the Pact, i.e. the attainment of sound budgetary balances in the medium-term, is more mitigated. This is all the more worrying as the ongoing economic recovery in the European Union, including the euro area, would make the case for more consolidation efforts not less. These conclusions are included in a Communication to Parliament and Council adopted today, which builds on the Annual report on the state of public finances in the European Union.

“By introducing more room for economic judgement, the reform has stimulated a more constructive and transparent economic policy dialogue at the EU level. It has strengthened peer support and pressure and contributed to a smooth and efficient operation of the Pact. But the hardest things remain to go beyond the correction of excessive deficits and ensure a comfortable budgetary position in the medium term by increasing consolidation efforts now that times get better,” said Economic and Monetary Affairs Commissioner Joaquin Almunia. “We cannot repeat the errors of the past if we want to manage ourselves a safe margin of manoeuvre for bad times and, as we must, roll back those excessive debts too”.

Today the Commission adopted a Communication which sets down the main policy conclusions of its 2006 report on Public finances in EMU. It also provides a first review of the implementation of the SGP, as revised in June last year, and of the challenges ahead.

The 2005 SGP reform brought about a significant improvement in the application of the excessive deficit procedure.

It has allowed better account to be taken of country-specific considerations relating to economic growth and the situation of their public finances while, at the same time, continuing to place all countries with deficits above 3% under the excessive deficit procedure.

Realistic deadlines have been set for the correction of excessive deficits, to take into account weak economic growth but the recommended structural fiscal adjustment is significant. This is even more so since the adjustment is now expressed net of one-off and temporary effects, thus ensuring that excessive deficits are corrected in a more permanent way.

Importantly, the increased flexibility and room for judgement was done without prejudice to the rules-based system for fiscal policy, which guarantees equal treatment of all Member States.

According to the budgetary results in 2005, the nominal deficit in the EU was reduced to 2.3% of GDP from 2.6% in 2004 (2.4% and 2.8%, respectively, in the euro area. In structural terms, this represents an improvement of around ¾ percent of GDP, which is the biggest budgetary adjustment since 1997.

Preventive arm

Almunia said that the Pact is not just about the correction of excessive deficits. The main objective is to ensure healthy medium-term objectives (MTOs) for public finances which are now recommended within a range between -1% of GDP for low-debt/high potential growth countries and balance or surplus for high-debt/low potential growth countries.

The examination of the first set of Stability and Convergence Programmes submitted after the reform of the Pact, shows that Members States have set themselves MTOs that are broadly in line with the agreed principles. Another positive development is that the budgetary projections are, in almost all cases, based on realistic growth assumptions and with little recourse to one-off and other temporary measures. Nevertheless, in some cases, the medium-term budgetary plans lack the necessary ambition to reduce the gap between current fiscal positions and the medium-term budgetary objectives. Larger fiscal adjustments should notably be made in 2006 and also 2007, in a context of economic recovery.

The 2006 Public Finances in EMU report also contains two analytical sections that focus a) on the role of national fiscal policy rules (e.g. expenditure ceilings, ‘national pacts’) and institutions as useful supplement of those of the Stability and Growth Pact; b) fiscal policy in "good times". Recent developments and the Commission’s spring 2006 forecast confirm that an economic recovery is under way in the euro area and in the EU. Member States need to avoid the errors of the past and make good use of good times to step up budgetary consolidation efforts.

Background

The Stability and Growth Pact is composed of the Treaty provisions on Economic and Monetary Policy (Title VII) of the EU Treaty as well as two 1997 Regulations on the surveillance of budgetary positions and on the correction of excessive deficits. These regulations were amended in June 2005. The report improving the implementation of the SGP and adopted by EU finance ministers in March 2005 is also an integral part of the EU’s budgetary surveillance architecture.

Full report available here.