Select Committee on European Union Forty-Ninth Report


Letter from the Chairman to the Minister, Ruth Kelly

  As you will be aware, since last December, Sub-Committee A (Economic and Financial Affairs, Trade and External Relations) has been conducting an inquiry into the Stability and Growth Pact. In connection with this inquiry, the Sub-Committee has under scrutiny the above Communication from the Commission. The Sub-Committee took evidence from a wide range of academics, the TUC, UNICE, the European Commission and yourself, representing the Government.

  The Sub-Committee has now completed its inquiry and drafted a report, which will be published in approximately two weeks' time. However, we are committed to giving the Government our conclusions before negotiations on the Commission Communication take place at the next meeting of the Ecofin Council on 7 March 2003. Accordingly, at its last meeting, the Committee agreed the key conclusions that have emerged from the inquiry. I trust that you will take full account of these recommendations when discussing the Stability and Growth Pact at the next Ecofin Council meeting and during your preparations for the meeting. The Committee's conclusions are as follows:


  The Committee supports the co-ordination of national fiscal policies across the EU with a view to maintaining sound public finances, Market discipline alone cannot be guaranteed to ensure the sustainability of public finances. A co-ordinating pact or other method of co-ordination between the Member States is necessary to deal with the "free-rider" problem, the risk of default and to help Member States to prepare for the economic effects of ageing populations in the EU; such a method of coordination should also provide stability for the European Central Bank and the market.

  The Committee agrees with the Government that it is extremely important that Member States are free to structure the expenditure and the revenue side of their budgets according to their own national preferences. This is not in question in any of the discussions on the Stability and Growth Pact, which deals only with levels of government debt and deficit.


  It should be made explicit that the medium-term target of budgets "close to balance or in surplus" is to be measured in terms of the cyclically- adjusted budget balance. The common methodology agreed and adopted by the Commission and Ecofin last year should be used to calculate the underlying budget balances for this target; this means that an extra body of experts is not needed to calculate the cycle.

  When monitoring Member States' compliance with the 3 per cent deficit criterion, the Commission should continue to use the actual deficit-to-GDP ratio.

  However, when deciding how the Pact is to be enforced, the Council should not treat the 3 per cent figure as an absolute limit, never to be breached. The Council's decision whether or not to implement the excessive deficit procedure, once a country has breached the 3 per cent reference value, should take account of the underlying economic situation, including the Member State's position in the economic cycle and possibly its level of debt.

  The Commission's proposal that Member States should set an adjustment path towards the medium-term target of budgets "close to balance or in surplus" of 0.5 per cent GDP per year should not be treated by the Council as an enforceable rule, any breach of which would activate the excessive deficit procedure.

  It is important to tackle the fact that the Stability and Growth Pact works asymmetrically across the economic cycle. Furthermore, countries need to be encouraged not to act pro-cyclically in times of boom. The Committee does not, however, consider that the Commission's proposal to apply the sanction of the excessive deficit procedure in good times would be the most effective way of achieving these twin objectives. The Committee shares the concern that the rules of the Pact should not be complicated. The number of situations that lead to the formal sanctions of the excessive deficit procedure being invoked should not be extended, or these measures will lose their force.

  We welcome the Commission's proposal to allow some Member States "a small deviation" from the "close to balance or in surplus" requirement. We support the fact that this proposal is only available to those countries with low underlying debt. We believe that the Government, too, should welcome this move to a more country-specific interpretation of the Pact, as it would allow them to target the UK national priorities of public investment in physical and human capital.

  We welcome the Commission's proposal to focus more on debt. The stability and convergence programmes of Member States with particularly high debt ratios should contain a clear commitment to an agreed trajectory of reducing debt. In the light of these commitments, the Council opinions on the stability and growth programmes should include guidelines for reducing debt.


  To ensure the credibility and proper functioning of the Stability and Growth Pact, situations such as the one last February—when the Council went against the Commission's recommendation and did not send early warnings to Germany and Portugal—must be avoided in the future. We therefore recommend that the Treaty be amended to grant the Commission the power to issue early warnings directly to Member States without recourse to the Council. This proposal is in line with the monitoring and surveillance functions of the Commission.


  The Commission's role should not be extended beyond the right to issue an early warning direct to a Member State. The Council should remain the final arbiter of all the enforcement procedures enshrined in the Pact. Only the Council should have the power to enforce sanctions through the excessive deficit procedure and to oblige Member States to take specific actions to remedy excessive deficits.

  Peer pressure is the most effective enforcement mechanism currently available in the Stability and Growth Pact. The sanction of fines is a "nuclear deterrent" only to be used as a measure of absolute last resort.


  Each of the Commission's proposals—to measure the medium-term target of budgets "close to balance or in surplus", to encourage Member States to reduce their underlying deficits to achieve this objective, to encourage countries not to act pro-cyclically in times of boom, to allow Member States with a low level of debt to deviate from the "close to balance or in surplus" target, to encourage highly-indebted countries to reduce their levels of debt—provides Member States with a useful aim and sound objective. However, they should be interpreted as guidelines rather than as rules. Interpreted in an inflexible way that takes no account of the particularities of each individual situation, they would increase the complication of the Pact. This could lead to more transgressions by the Member States and more interventions by the Commission and the Council, which could possibly threaten to undermine the credibility of the very rules that the proposals seek to strengthen. Interpreted in a way that is sensitive to the specific circumstances of each country, the proposals would introduce the necessary extra benchmarks against which the budgetary actions of Member States could be judged and around which peer pressure could be applied in the Council. Such an interpretation should encourage Member States to follow sensible fiscal policies, which could lead to greater stability and growth.

  The Committee continues to hold the Commission Communication under scrutiny.

  The Committee has asked to receive in good time ahead of the European Council on 21 March a full report of the discussions on the Commission Communication at the Ecofin Council meeting on 7 March 2003, including an account of the position adopted by the United Kingdom and the other Member States.

3 March 2003

Letter from the Minister, Ruth Kelly, to the Chairman

  Thank you for your letter of 3 March. I was interested to read the outline of the Sub-Committee's key conclusions resulting from its inquiry into the Stability and Growth Pact ahead of the 7 March ECOFIN Council meeting and look forward to the publication of their report in due course.

  In response to your request for further information on the ECOFIN discussions, I enclose for your attention the ECOFIN report on "strengthening co-ordination of budgetary policies", which was approved by the Council and which the Council decided to transmit to the European Council (7208/03. Not printed) This Report reflects the views of all of the Member States of the European Union and was agreed collectively by their Finance Ministers on 7 March 2003.

  May I also draw your attention to the recent answer given by the Chancellor of the Exchequer to the parliamentary question tabled by the Member of the House of Commons for Falkirk East (Mr Michael Connarty) on the outcome of the latest ECOFIN discussions (Column 491W, 14 March 2003). ECOFIN is an intergovernmental body, which is why its collective decisions/conclusions (by QWV unanimity or simple majority) are reported alongside UK positions. The Government has made consistently clear that it supports a prudent interpretation of the Stability and Growth Pact, which takes into account the enconomic cycle, sustainbility and the important role of public investment.

17 March 2003

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