In comments on Philip’s Sunday Business Post article, Bryan G raises a number of important points about what actually changes as a result of the Fiscal Compact. I think an important role for this forum is to discuss what the Compact actually does, so thanks to Bryan for focusing on the question. For one thing, it may reveal areas where clarifications from the Commission are required so informed decisions can be made.
Bryan G identifies what he sees as the major consequences of the Compact:
(a) requiring rapid convergence to MTO [Medium-Term Budgetary Objective]
(b) limiting the scope for temporary deviations due to exceptional circumstances
(c) requirement for an automatic correction mechanism
(d) requirement for Member States that have been made subject to the excessive deficit procedure to put in place budgetary and economic partnership programmes
(e) the ex ante reporting of public debt issuance plans.
(f) defining the scope and procedures for Euro Summit meetings
Points (d) and (e) are the subject of the proposed two-pack. Point (f) seems uncontroversial. I think Bryan G is right that point (c) is a — indeed I would say the — critical element of the Compact, and relates to the requirement to put a correction mechanism into “binding and permanent” national law. From my reading of the proposed Compact and the revised Stability and Growth Pact (SGP), I do not see the case for (a) and (b) being real innovations. Here is the critical Article 3 of the Compact:
1. The Contracting Parties shall apply the rules set out in this paragraph in addition and without prejudice to their obligations under European Union law:
(a) the budgetary position of the general government of a Contracting Party shall be balanced or in surplus;
(b) the rule under point (a) shall be deemed to be respected if the annual structural balance of the general government is at its country-specific medium-term objective, as defined in the revised Stability and Growth Pact, with a lower limit of a structural deficit of 0,5 % of the gross domestic product at market prices. The Contracting Parties shall ensure rapid convergence towards their respective medium-term objective. The time-frame for such convergence will be proposed by the European Commission taking into consideration country-specific sustainability risks. Progress towards, and respect of, the medium-term objective shall be evaluated on the basis of an overall assessment with the structural balance as a reference, including an analysis of expenditure net of discretionary revenue measures, in line with the revised Stability and Growth Pact;
(c) the Contracting Parties may temporarily deviate from their respective medium-term objective or the adjustment path towards it only in exceptional circumstances, as defined in point (b) of paragraph 3;
(d) where the ratio of the general government debt to gross domestic product at market prices is significantly below 60 % and where risks in terms of long-term sustainability of public finances are low, the lower limit of the medium-term objective specified under point (b) can reach a structural deficit of at most 1,0 % of the gross domestic product at market prices;
(e) in the event of significant observed deviations from the medium-term objective or the adjustment path towards it, a correction mechanism shall be triggered automatically. The mechanism shall include the obligation of the Contracting Party concerned to implement measures to correct the deviations over a defined period of time.
2. The rules set out in paragraph 1 shall take effect in the national law of the Contracting Parties at the latest one year after the entry into force of this Treaty through provisions of binding force and permanent character, preferably constitutional, or otherwise guaranteed to be fully respected and adhered to throughout the national budgetary processes. The Contracting Parties shall put in place at national level the correction mechanism referred to in paragraph 1(e) on the basis of common principles to be proposed by the European Commission, concerning in particular the nature, size and time-frame of the corrective action to be undertaken, also in the case of exceptional circumstances, and the role and independence of the institutions responsible at national level for monitoring compliance with the rules set out in paragraph 1. Such correction mechanism shall fully respect the prerogatives of national Parliaments.
3. For the purposes of this Article, the definitions set out in Article 2 of the Protocol (No 12) on the excessive deficit procedure, annexed to the European Union Treaties, shall apply.
The following definitions shall also apply for the purposes of this Article:
(a) “annual structural balance of the general government” refers to the annual cyclically-adjusted balance net of one-off and temporary measures;
(b) “exceptional circumstances” refers to the case of an unusual event outside the control of the Contracting Party concerned which has a major impact on the financial position of the general government or to periods of severe economic downturn as set out in the revised Stability and Growth Pact, provided that the temporary deviation of the Contracting Party concerned does not endanger fiscal sustainability in the medium-term.
For Bryan G’s point (a), the relevant part is paragraph 3(1b). It is true that the Compact raises the maximum structural deficit to 0.5 percent of GDP (from 1 percent of GDP) unless the country has a debt to GDP ratio of less than 60 percent. However, given that Ireland has a country-specific MTO of -0.5 percent already, this change in the allowable range does not bind (see page 39 of the most recent Stability Programme Update). On the speed of convergence, I don’t see any change from the revised SGP. The recent Commission document on the implementation of the SGP uses very similar language to the Compact on how “sufficient progress” is evaluated:
Sufficient progress towards the MTO shall be evaluated on the basis of an overall assessment with the structural balance as the reference, including an analysis of expenditure net of discretionary revenue measures.
Note also the “in line with the revised Stability and Growth Pact” in 3(1b) above.
On the exceptional circumstances provisions (Bryan G’s point (b)), here again is the language from the SGP implementation document:
In case of an unusual event outside the control of the Member State concerned and which has a major impact on the financial position of the general government or in periods of severe economic downturn for the euro area or the Union as a whole, Member States may be allowed to temporarily depart from the adjustment path towards the medium-term objective implied by the benchmarks for the structural balance and expenditure, on condition that this does not endanger fiscal sustainability in the medium-term.
Again I do not see any major change here, but I may be missing something.
As noted above, the major innovation of the Compact is the domestically enforced correction mechanism, which is to be designed according to “common principles to be proposed by the European Commission”. I think it is essential that we should be given more information on what these principles will be. The SGP implementation document may give some important clues.
The identification of a significant deviation from the medium-term budgetary objective or the appropriate adjustment path towards it should be based on outcomes as opposed to plans. It should follow an overall assessment, with the structural balance as a reference, including an analysis of expenditure net of discretionary revenue measures. For a Member State that has not reached its MTO, the deviation will be considered significant if:
(i) the deviation of the structural balance from the appropriate adjustment path is at least 0.5% of GDP in one single year or at least 0.25% of GDP on average per year in two consecutive years; and
(ii) an excess of the rate of growth of expenditure net of discretionary revenue measures over the appropriate adjustment path defined in relation to the reference medium-term rate of growth has had a negative impact on the government balance of at least 0.5 of a percentage point of GDP in one single year, or cumulatively in two consecutive years; or if one of the two conditions (i) and (ii) is verified and the overall assessment evidences limited compliance also with respect to the other condition.
The government expenditure aggregate to be assessed should exclude interest expenditure, expenditure on EU programmes fully matched by EU funds revenue, and non-discretionary changes in unemployment benefit expenditure. Due to the potentially very high variability of investment expenditure, especially in the case of small Member States, the government expenditure aggregate should be adjusted by averaging the investment expenditure over four years. The excess of expenditure growth over the medium-term reference will not be counted as a breach of the expenditure benchmark to the extent that it is fully offset by revenue increases mandated by law.
For a Member State that has overachieved the MTO, the occurrence of condition (ii) is not considered in the assessment of the existence of a significant deviation, unless significant revenue windfalls are assessed to jeopardise the MTO over the programme period.
A deviation may not be considered significant in the case of severe economic downturn for the euro area or the EU as a whole or when resulting from an unusual event outside of the control of the Member State concerned which has a major impact on the financial position of the general government, provided that this does not endanger fiscal sustainability in the medium-term.
Thanks to Bryan G for focusing attention on these important questions.