11 MARCH 2003
By the Select Committee appointed to consider European
Union documents and other matters relating to the European Union.
THE STABILITY AND GROWTH PACT
COM (2002) 668 Final Communication from the Commission
to Council and the European Parliament: "Strengthening the
co-ordination of budgetary policies", Brussels, 27.11.2002
PART 1:EXECUTIVE SUMMARY
In the European Union, the national budgets of the
Member States are subject to the constraints of the Stability
and Growth Pact. In particular, the Pact imposes tight limits
on government deficits and debt However, the Pact has come in
for heavy criticism over the past year, as several large Member
States are breaching the rules of the Pact. The Pact is under
immense strain and pressure; some people have even said that the
Pact should be torn up and that completely new fiscal rules need
to be established for the EU. In the hope of rescuing the Pact's
credibility, the Commission proposed a series of reforms at the
end of last year.
The European Heads of State and Government will discuss
the Stability and Growth Pact and these possible reforms at the
European Council meeting in Brussels on 20-21 March.
This report examines the reasons why the EU has a
Stability and Growth Pact and asks how it should be reformed.
We analyse each of the Commission's proposals and assess their
The Committee recommends:
target of budgets 'close to balance or in surplus' should be measured
in terms of the cyclically-adjusted budget balance. Member States
with a low level of underlying debt should be allowed "a
small deviation" from the target.
Council should not treat the 3 % of GDP ceiling on deficits as
an absolute limit. The decision to implement sanctions should
take account of the underlying economic situation, including the
Member State's position in the economic cycle and possibly its
level of debt.
Commission should have the power to issue early warnings directly
to Member States.
The Committee advocates a flexible interpretation
of the Pact. This would provide additional flexibility for those
countries (particularly Germany and Portugal) that currently need
it. Our recommendations could also be used to allow greater short-term
flexibility to low-debt countries with sound public finances (such
as the UK) and so provide an incentive for highly indebted countries
(such as Greece and Italy) to reduce their level of debt. As such,
our recommendations should restore credibility to the Pact and
help Member States to maintain sound public finances. We conclude
that the Commission proposals can be used as a good basis to achieve
the necessary flexibility for the Stability and Growth Pact, as
they can be read as offering sound guidelines for Member States
to follow. However, interpreted differently, they could be used
to add a new set of extra rules to the Pact. Such an interpretation
of the Commission proposals would move the Pact in the wrong direction,
by making it more rigid. We therefore call on the Government to
ensure that the Commission's proposals are interpreted in the
flexible way proposed by the Committee.
What is the Stability and Growth
1. The Stability and Growth Pact sets out rules
for the European Union, establishing a framework within which
Member States have agreed to coordinate their fiscal policies.
For whilst monetary policy in the euro area has been unified and
is now conducted by the European Central Bank (ECB), fiscal policy
remains a matter for national governments. The fiscal policies
of the Member States are, however, subject to the constraints
of the Stability and Growth Pact (SGP). This comprehensive surveillance
procedure, which involves monitoring the national budgets across
the European Union (EU), is aimed at ensuring the fiscal discipline
of the Member States. Whether or not a Member State has adopted
the euro, "Member States are free to structure the expenditure
and the revenue side of their budgets according to their own national
preferences" (Q 267). "But, subject to that, Member
States have agreed a framework [in the Stability and Growth Pact]
for the coordination of fiscal policy, with a view to maintaining
sound public finances" (p. 44). In particular, the Pact imposes
tight limits on government deficits.
2. The SGP, which was adopted at the Amsterdam
European Council in June 1997, complements and strengthens the
provisions of the EC Treaty on budgetary discipline. To understand
the Pact, therefore, it is sensible to examine first the relevant
EC Treaty provisions on economic policy.
The EC Treaty and Excessive Deficits
3. Under Article 99 of the EC Treaty Member States
agree to "regard their economic policies as a matter of common
concern" and accordingly to "coordinate them within
the Council". Of particular importance in this regard is
the Excessive Deficit Procedure (EDP), which is set out in Article
104 of the EC Treaty.
Box 1 Economic and Monetary Union (EMU)
|The Delors Report in 1989 envisaged a three-stage transition to full Economic and Monetary Union (EMU). The EC Treaty, as revised in Maastricht, set out a timetable for the transition to the final stageStage Threeof EMU.
Stage Three of EMU started on 1 January 1999, when the exchange rates of participating currencies were locked together and these currencies became denominations of the single currency, the euro. Euro notes and coins followed three years later, on 1 January 2002, and gradually replaced participating national currencies.
Responsibility for determining monetary policy for those countries participating in Stage Three passed to the Governing Council of the European System of Central Banks, which consists of members of the Executive Board of the European Central Bank, plus governors of participating Member States' national central banks.
12 EU countries have now adopted the euro: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. The other three EU countries have not adopted the euro and remain at Stage Two of EMU: Denmark, Sweden and the United Kingdom.
4. Member States in Stage Three of Economic and
Monetary Union (EMU) "shall avoid excessive government deficits",
as defined in Article 104 and Protocol No 20 on the EDP, which
is annexed to the EC Treaty. Member States, like the UK, that
are in the Second Stage of EMU "shall endeavour to avoid
excessive deficits", rather than be obliged to "avoid
excessive deficits" (Article 116(4) of the EC Treaty). As
part of the EDP, all EU Member States must submit Excessive Deficit
returns to the European Commission on 1 March and 1 September
5. The Commission examines these returns and
thereby monitors Member States' compliance with the Pact's rules
on budgetary discipline and makes judgments on the existence or
otherwise of excessive deficits. In accordance with Article 104(2),
the Commission uses two criteria for this task:
(a) Whether the ratio of the planned or actual
government deficit to gross domestic product (GDP) exceeds 3 %.
Deficits above this limit will be considered excessive except
when temporary and due to exceptional circumstances.
(b) Whether the ratio of government debt to GDP
exceeds 60 %, unless the ratio is sufficiently diminishing and
approaching the reference value at a satisfactory pace.
6. As with any numerical threshold, the figures
have a certain degree of arbitrariness. The figure for the debt
ratio was slightly above the EU average when the Treaty was negotiated,
while the deficit reference value was below, though it had been
met in the late 1980s. If the Commission believes that a Member
State has exceeded, or is at risk of exceeding, the values for
government deficit or government debt, it should prepare a report
as the first stage in the EDP, which can eventually lead to sanctions
in the form of fines. To understand properly the EDP as it now
functions, it is necessary to examine the Stability and Growth
Pact, which clarifies how the EDP works.
The legal elements of the Stability
and Growth Pact
7. The Stability and Growth Pact entered into
force on 1 January 1999 with the transition to Stage Three of
EMU. The Pact consists of three elements: a Resolution of the
European Council and two Regulations.
first Regulation (No 1466/97) focuses on the prevention of excessive
second Regulation (No 1467/97) focuses on deterrence, by clarifying
how the EDP is to be implemented against Member States with excessive
Resolution provides guidance to the Member States, the Commission
and the Council on the application and implementation of the Pact.
The Amsterdam Resolution
8. In the European Council Resolution, agreed
at Amsterdam on 17 June 1997, the European Heads of State and
Government decided to go beyond the provisions of the EC Treaty.
They committed themselves to the medium-term target of achieving
budgets that are 'close to balance or in surplus'. The idea was
that attaining such a position would give the Member States a
safety margin which would allow them to deal with cyclical fluctuations,
while always keeping the government deficit below the reference
value of 3 % of GDP.
Regulation on surveillance and co-ordination.
9. Council Regulation (EC) No 1466/97 embodies
the preventive elements of the Pact. The Regulation aims to prevent
at an early stage the emergence of an excessive deficit. To this
end, it establishes two key preventative measures:
surveillance of Member States' respect of budgetary commitments;
warnings in the event of non-respect of budgetary targets.
10. The main tools of multilateral surveillance
are the Member States' annual stability or convergence programmes.
The Regulation defines the contents of these programmes and sets
out rules for their submission, examination and monitoring. In
these programmes, Member States set out their short- and medium-term
budgetary strategies to reach and sustain budget positions that
are 'close to balance or in surplus'. As well as this adjustment
path towards meeting the medium-term budgetary objective of the
SGP, Member States also submit the expected path of the general
government debt ratio.
The Member States submit their programmes to the Commission at
the end of each calendar year. The Commission then assesses them,
and, on the basis of the Commission's recommendation, the Council
delivers an opinion.
11. In the event of a significant divergence
of the budgetary position of a Member States from the medium-term
budgetary objective, or the adjustment path towards it, the second
preventive measure can be activated. This is referred to as the
early-warning mechanism; it involves the Council, on the basis
of a Commission recommendation, addressing an early warning to
the Member State, urging corrective action. In this early warning,
the Council would recommend particular actions to rectify the
budgetary slippage. The Commission explains the early-warning
mechanism as follows:
"The purpose of the early warning is to send
a signal to the Member State concerned that the budgetary targets,
which had been endorsed by the Council, have not been adhered
to. It also gives the Member States sufficient time to take corrective
measures if appropriate so as to avoid budget deficits approaching
the 3 % of GDP reference value. As such, it is an important signalling
device on the need for enhanced vigilance. The Pact foresees a
clear sequencing of events, with an early warning being issued
prior to recourse being made to the dissuasive elements of the
SGP, namely the excessive deficit procedure."
Regulation on the excessive deficit
12. Council Regulation (EC) No 1467/97 is considered
to represent the dissuasive side of the SGP, because it provides
a detailed clarification and a speeding up of the sanction mechanisms,
building on the EDP as set out in Article 104 of the EC Treaty.
The purpose of the Regulation is thereby to deter excessive deficits
and, if they occur, to further their prompt correction, by means
of a set of rules for the application of Article 104.
13. Once the deficit of a Member State goes above
3 % of GDP, the Council must judge that the country has an excessive
deficit, unless the breach is due to exceptional circumstances,
is temporary and the deficit remains close to the reference value.
The Regulation spells out (Article 2(2) and (3)) what is meant
by "exceptional and temporary" in Article 104, which
defines when the 3 % limit may be exceeded. The Commission has
to apply tighter rules than the Council for qualifying a deficit
over the reference value as exceptional:
· As a
rule, a deficit is automatically considered exceptional by the
Commission if output fell by at least 2 % of GDP in the year in
· In addition
to considering a deficit exceptional if output fell by at least
2 %, the Council may consider a deficit to be exceptional if output
fell by 0.75-2 %.
14. As can be seen, the Council has some discretionary
room in deciding whether a deficit owing to a severe economic
downturn is exceptional and hence not excessive. Where an excessive
deficit is judged by the Council to exist, the Member State concerned
is required to take measures that aim at bringing deficits below
the 3 % of GDP reference value. A repeated failure to take corrective
measures could eventually lead to the imposition of sanctions,
which ultimately take the form of fines.
15. The Regulation specifies the rules on sanctions,
together with guidance on their application, and sets deadlines
for implementing the different steps in the procedure. It sets
a deadline for decisions on sanctions and
requires, as a rule, a non-interest-bearing deposit from the Member
States concerned, which is to be converted into a fine if, two
years later, the excessive deficit still persists.
16. When there is progress in correcting the
excessive deficit, sanctions can be abrogated. However, the request
for a deposit will be lifted only once the Council concludes that
the excessive deficit had been corrected. Fines will not be reimbursed.
1 In line with Council Regulation (EC) No 3605/93,
of 22 November 1993, on the application of the Protocol on the
Council Regulation 1466/97  OJ L209/1 (on the strengthening
of the surveillance and co-ordination of budgetary policies). Back
Council Regulation 1467/97  OJ L209/6 (on speeding up and
clarifying the implementation of the excessive deficit procedure). Back
Resolution of the European Council on the Stability and Growth
Pact, Amsterdam, 17 June 1997, OJ C 236, 02/08/1997, pp. 0001-0002. Back
Member States in Stage Three of EMU submit stability programmes;
Member States outside the Eurozone submit convergence programmes.
In contrast to stability programmes, the convergence programmes
also deal with monetary policy and aim at achieving sustained
Public Finances in EMU-2002, European Economy No.3,
2002, pp.45-46. Back