17 October 2013

Fitch: Eurozone fiscal governance progresses, challenges remain

The submission of 2014 draft budgets by the 17 members of the eurozone to the European Commission is an important step towards deeper fiscal and financial integration in the single currency bloc, Fitch Ratings says.

Progress towards deeper integration underpins our sovereign ratings for those countries and is in line with commitments by euro area policy-makers. But the new budgetary surveillance system also demonstrates some of the challenges that this process will face. 

The Commission will review the budgets by the end of November and publish its opinion on the compliance with fiscal rules. It can publicly request the revision of any budget deemed out of line with medium-term targets. 15 October was the deadline for eurozone members to publish draft budgets for review under the so-called "Two Pack" regulations that came into force at the end of May. 

In line with the new rules, the Commission's assessment will focus on the structural fiscal position, filtering out cyclical and one-off effects. However, the calculation of the structural position, especially measuring the output gap in real time, is analytically challenging and several issues have been raised by the European Central Bank regarding the Commission's methodology. A fiscal rule that is not based on a directly observable target is less transparent. 

For example, according to Italy's draft budget the structural deficit in 2013 will be only 0.4 per cent of the GDP, while the headline deficit will be very close to 3 per cent. Financing needs are determined by headline deficits that remain wide in all periphery countries, and ultimately drive debt dynamics and determine debt sustainability. Economic growth also remains vitally important in securing debt sustainability.

In its latest Eurozone Snapshot, Fitch forecast debt to continue to increase beyond 2015 in Cyprus, Spain, Portugal, Slovenia and the Netherlands. Medium-term public debt projections remain a key factor driving our individual sovereign ratings, but the new budgetary surveillance process is also part of the moves to reform and enhance economic governance in the eurozone as a whole. The fact that this week's deadline was met by all eurozone members suggests a strong commitment to the new enhanced fiscal framework. But the real test of its effectiveness will be to improve debt sustainability in all Member States, and that has yet to be seen.

Press release

Eurozone Snapshot (registration)

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