EU fiscal rules post COVID-19: ‘back to normal’ or ‘time to change’?

8 July 2020: Debate is growing about what follows next after the European Commission decision to suspend EU fiscal rules during the coronavirus pandemic, writes Susanna Di Feliciantonio, Head of European Affairs at ICAEW.

Responding to the immediate stress on public finances across Europe in March as the COVID-19 pandemic took hold, the European Commission activated – for the first time – the ‘general escape clause’ in the European fiscal framework. This has allowed governments fiscal flexibility to take extraordinary measures to tackle the pandemic and its impact.

Debate is now growing about what to do next given that the decision to relax the fiscal rules came without a sunset clause or a timetable for review.

Fiscal respite – how long is temporary?

The economic consequences of the coronavirus pandemic have been unprecedented. 

The Commission’s economist forecasts have been revised downwards and now suggest that the EU economy will shrink by over 8 percent of GDP in 2020 – with some countries likely to experience double-digit dips.  As reported previously, discretionary fiscal measures taken by EU governments have been estimated at 3.25 percent of GDP, in addition to automatic stabilisers amounting to close to 5 percent. Fiscal deficits are surging and are expected to reach 8.5 percent of aggregate EU GDP this year. 

The EU’s debt-to-GDP ratio is expected to climb to 103 percent, with some countries faring particularly badly. Under EU treaty provisions, member states are supposed to keep government deficits under 3 percent of GDP and to achieve a debt-to GDP ratio below 60 percent.

The European Fiscal Board (EFB) commented in a recent report that the activation of the general escape clause has provided ‘a temporary fiscal breather’ but returning to the rules will not be easy and is already becoming the subject of political debate.

For European Commission Vice President Valdis Dombrovskis, the clause will be de-activated when the EU is no longer in a phase of severe economic downturn. But in the absence of an agreed definition of a severe economic downturn, EU leaders may take different views on how long the exceptional situation lasts – particularly if the speed of recovery differs across countries. Hence the calls by the EFB for urgent discussion and agreement on the conditions for returning to existing rules.

While warning against a premature of withdrawal of fiscal support measures given the uncertainties ahead, the EFB is asking for a review date no later than spring 2021.

Do EU fiscal rules need adapting?

The impact of the coronavirus is re-galvanising discussions on the need – or not – to update EU fiscal rules. Although the Commission’s broader review of European economic governance has been paused, probably until the autumn, many of the questions raised have become even more pressing.

A number of voices are stressing the need to learn from the aftermath of the financial and sovereign debt crisis of the past decade. For Mario Centano, outgoing president of the Eurogroup, the EU needs find a way to both progressively reapply fiscal rules without risking a double-dip recession and to take a more fundamental look at the existing, complex rulebook.

Economy Commissioner, Paolo Gentiloni, has stressed the need for a more strategic discussion on the substance of the EU’s fiscal position rather than a debate centred on threshold levels.

The EFB has gone further, calling for new rules based on a simple medium-term debt anchor (effectively doing away with the 60 percent debt target) and an operational target in the form of an expenditure benchmark on a single target. The latter aims to ensure greater focus on growth-enhancing government expenditure, including investment. Greater clarity on the application of the general escape clause will also be necessary.

Government finances are now one of the most significant topics of debate amongst EU member states, with the multi-annual financial framework for the next seven years and proposed recovery funds also under discussion.