Select Committee on European Union Thirteenth Report


11 MARCH 2003

By the Select Committee appointed to consider European Union documents and other matters relating to the European Union.



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


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 likely effects.

The Committee recommends:

·  The 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.

·  The 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.

·  The 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 Pact?

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 stage—Stage Three—of 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 each year.[1]

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.

·  The first Regulation (No 1466/97) focuses on the prevention of excessive deficits;[2]

·  the second Regulation (No 1467/97) focuses on deterrence, by clarifying how the EDP is to be implemented against Member States with excessive deficits;[3] and

·  the Resolution provides guidance to the Member States, the Commission and the Council on the application and implementation of the Pact.[4]

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:

·  regular surveillance of Member States' respect of budgetary commitments; and

·  early 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.[5] 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."[6]

Regulation on the excessive deficit procedure

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 question.

·  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 EDP. Back

2   Council Regulation 1466/97 [1997] OJ L209/1 (on the strengthening of the surveillance and co-ordination of budgetary policies). Back

3   Council Regulation 1467/97 [1997] OJ L209/6 (on speeding up and clarifying the implementation of the excessive deficit procedure). Back

4   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

5   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 convergence. Back

6   Public Finances in EMU-2002, European Economy No.3, 2002, pp.45-46. Back

previous page contents next page

House of Lords home page Parliament home page House of Commons home page search page enquiries index

© Parliamentary copyright 2003