05 March 2021

Bruegel: The EU’s fiscal stance, its recovery fund, and how they relate to the fiscal rules

Joint EU borrowing to boost the recovery, if not treated as national deficit and debt, will substantially ease rules-based fiscal adjustment needs in southern and eastern Europe, but not in western and northern Europe.

By now, the broad outlines of the European Union’s post-coronavirus recovery fund, Next Generation EU, are well known. Under NGEU, the European Commission will borrow up to €806 billion (current prices) and distribute it over six years to all EU countries. Most (€420 billion) will be distributed as grants while up to €386 billion could be distributed as credit. In addition, €90 billion (at current prices) in loans has already been granted to 18 EU countries from the temporary scheme, Support to mitigate Unemployment Risks in an Emergency (SURE), to help with the financing of short-time work schemes and similar measures.

But the impact of NGEU on the EU’s currently suspended fiscal rules has been barely discussed. How will these substantial transfers be accounted for in the EU’s fiscal framework and what are the implications for the fiscal stance? Though a debate on the future of the EU fiscal rules is underway (for example, whether the rules should be replaced by standards, or completely redefined), these questions have so far been neglected.

Accounting for NGEU grants and loans at EU level only?

The Bundesbank December 2020 Monthly Report called for EU debt to be counted towards national debt and deficits, similarly to the debts arising from the European Financial Stability Facility (EFSF), which are attributed to EU countries. There are good reasons, however, why this should not be done, and we understand that Eurostat and the European Commission do not plan to allocate the EU debt and deficit to national debts and deficits. The main reason for this is that such an allocation would be extremely difficult, or even impossible: the repayment of EU debt cannot be clearly allocated to any national treasury. It is impossible to make reasonable estimates of how much each EU country would contribute to the repayment of the EU debt, starting from 2027 and running to 2058, related to the financing of NGEU grants, partly because it depends on many unknown future developments such as relative GNI developments in EU countries in the next four decades. Moreover, some of the money for repayment is supposed to be raised from newly created EU taxes, such as the unrecycled plastics tax. Allocating a ‘federal’ debt to national budgets would make that debt de-facto national debt. While the underlying taxpayers obviously are all EU tax subjects, the character of NGEU debt is clearly very different to national debt.

Loans granted by NGEU to member states have the specific characteristic that the borrower country is obliged to repay that in full, even if the underlying borrowing is guaranteed by EU countries and the EU budget. Thus, NGEU loans should contribute to headline national public debt and deficit numbers. However, if spending financed by such loans does not benefit from special treatment in the EU fiscal framework, borrower countries will have to reduce their non-NGEU spending once the currently suspended fiscal rules are re-activated. A simple way to avoid this is to treat all NGEU-financed expenditure as one-off and exclude it from the structural balance (headline budget balance adjusted by the impact of the economic cycle and one-off expenditure and revenue measures), because fiscal adjustment under the EU rules is defined by the change in the structural balance. Similar treatment is needed to assess compliance with the expenditure benchmark.

EU fiscal rules and NGEU

So how would these grants to national budgets, assuming they do not count towards national deficits and debts, change the budget positions of countries, and what will be the interplay with the fiscal rules? EU rules limit public debt and budget deficits in various ways. If the budget deficit is larger than 3% of GDP, or public debt is more than 60% of GDP and does not decline by the 1/20^th of the gap relative to the 60% threshold, the deficit is considered excessive and an excessive deficit procedure (EDP) aims to force the reduction of the deficit....

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