One month ago, we reported that Europe, already sliding into a stagflationary recession, was about to unleash the same crushing austerity that brought the continent to the verge of collapse over a decade ago. That's when the German government - one day after the German constitutional court ruled a decision to move €60BN from unused pandemic funds in 2021 into the Energy and Climate Fund, later renamed the Climate and Transformation Fund (KTF), was unconstitutional and void - froze public spending for the rest of the year, dealing a blow to Europe’s recovery and efforts to beef up Zelensky's offshore bank accounts Ukraine's military and reduce carbon emissions. Which is why many were closely watching the outcome of last week's European fiscal reform negotiations to see just how much worse Europe's upcoming austerity could be.
The outcome: after months of haggling, EU finance ministers bowed to German pressure for tough debt-reduction rules, as part of a deal to phase in a sweeping overhaul of the union’s budget framework; the package as detailed by the FT, gives EU member states greater independence on agreeing debt and deficit plans with Brussels, but only within tight spending limits demanded by fiscal hawks.
The compromise agreed between EU member states built on original proposals from the European Commission, which sought to give countries more independence in setting debt reduction plans, yet in the end, it all again boils down to what Germany wants.
Under the framework, the commission will draw up national spending plans over four years ensuring debt is put on a declining path (which will never happen in a world where virtually all growth is now funded by debt). Countries can extend these up to seven years by committing to growth-enhancing reforms, which simply means that debt will grow to all time highs... then grow even more as politicians admit that there are no growth plans that can lead to a net reduction in debt/GDP.
Although high-debt states - which in Europe is pretty much all - were given some extra wriggle room as part of a transition period, the new framework included stricter overall limits on spending that were crucial to winning over Germany, which was deeply sceptical about the original reforms. The political deal, struck after the traditionally marathon negotiations between capitals, must still be agreed with the European parliament to become law.
Two fiscal benchmarks, which are included in EU treaties, remain unchanged: a 60 per cent debt-to-GDP ratio and a 3 per cent annual deficits limit. Ministers agreed to ditch a separate requirement to cut excess debt by 5% per year, simply because debt reduction in modern financial systems is no longer a possibility even in the realm of European political fables.
To improve enforcement, the ministers decided to introduce a yearly spending cap that will become main benchmark used to assess a country’s compliance with its fiscal plan. These plans will be flanked by two “safeguards” added at the behest of a group of countries led by Germany, who criticised the commission’s proposals as too lax.
Countries with debt ratios above 90% of GDP will be required to cut excess debt by one percentage point per year over the duration of their national spending plan. That target is halved for countries with debt ratios above 60 per cent but below 90 per cent of GDP.
Sanctions are strengthened under the deal, with countries missing spending plan targets falling into a so-called excessive deficit procedure, which would require them to reduce spending by 0.5% of GDP per year. In other words, a fiscal "debt brake" similar to the one that Germany almost had.... but quickly abandoned when it became clear that a flood of new debt is needed to kickstart Europe's economy in the aftermath of the covid pandemic.
Hilariously, the commission has already said that a large number of draft budget plans for 2024 do not comply with the required thresholds and will be sanctioned after EU elections. But - once again confirming that no European "reform" is worth the paper it is printed on - a last-minute concession won by France ensured that countries subject to such a procedure will be able to discount debt interest costs in the period 2025-2027, effectively reducing the required spending curbs.
Realizing just how toothless the whole farce is, Italy finance minister Giancarlo Giorgetti, who had earlier threatened to veto the proposals, ultimately told his colleagues he would relent “in the spirit of compromise." Translation: the new debt-reduction rules are a joke, something which wasn't lost even on Europe's career clowns bureaucrats:
“The impression is that countries such as France and Italy have accepted some commitment that would not be binding on them in the short term, in the conviction that it will never be applied,” said Lucio Pench, the author of the commission’s original proposal, now a non-resident fellow with think-tank Bruegel.
Commenting on the outcome, TS Lombard analyst Davide Oneglia is laconic: "In classic EU style, member states have reached a last-minute agreement to reform the bloc’s fiscal rules – a complex compromise brokered by Germany and France that allows everybody to claim victory, even Italy. The new framework broadly follows the European Commission’s (EC) proposal, which tried to strike a balance among simpler but more easily enforceable rules, slower fiscal consolidation and more leeway for public investment. In so far as these goals have been partly fulfilled, the compromise is a step forward compared with the old rules – so strict (especially since Covid) to prevent implementation. However, negotiations have both improved and worsened the EC proposal, favoring incumbent governments by adding some short-term flexibility at the expense of tougher long-term commitments."
- On the positive side, the deal retains the key elements of the EC framework: a long-term debt-sustainability analysis (DSA) to evaluate member states’ progress on multi-year structural plans (4 years, extendible to 7) negotiated with the EC to ensure the projected “net expenditure path” (i.e. the growth rate of government spending, netted out for factors such as interest rate payments and cyclical unemployment spending) is consistent with gradual debt reduction. While the EC will run the DSA, this will now also need to be approved by the Council. Moreover, the annual minimum requirement of debt reduction to be achieved regardless of DSA’s results was revised so to start only once the deficit falls below 3% of GDP. To enhance flexibility, countries are allowed to deviate from the net expenditure path by 0.3% of GDP annually and by 0.6% cumulatively during a monitoring period.
- On the negative side, Germany managed to impose two new “safeguards” that will haunt policymakers. First, countries reducing the deficit below 3% need to carry on with fiscal adjustments at a pace of 0.4% of GDP/year over 4 years or 0.25%/year over 7 years until the deficit falls below 1.5% to build a safety buffer. A very onerous requirement for countries like Italy, as it implies a primary structural surplus of 4% of GDP. Second, countries with debt/GDP ratio above 90% need to reduce it by 1%/year, while those with debt between 60% and 90% need to cut it by 0.5%. On paper this debt adjustment is less restrictive than that under the old rules, but tougher enforcement means constraining fiscal space in the long run.
Ultimately, high debt countries focused on short-term gains, meaning they will be allowed to build up even more debt leading to the next European debt crisis at which point Europe will pretend to make even more difficult decisions which will achieve nothing but put the continent even more in debt, requiring even bigger centrla bank bailouts and so on. As noted above, France obtained that countries with deficit above 3% will be able until 2027 (purely "coincidentally" the year of the next Presidential election) to exclude interest payments from the figures used to calculate the adjustment. Italy also obtained that the plan of investment and reforms agreed with the EC under the Recovery Plan will be enough to automatically secure a 7-year adjustment period.
Bottom line: another farcical deal that optically that papers over Europe's insolvency (oh but look how late and hard these career politicians - who are paid only to pretend they work late and hard - worked to get it done, please clap), which is only able to exist day to day thanks to the generosity of the ECB's illegal monetary financing apparatus, yet which continues to this day despite being illegal and in explicit violation of EU law.
No wonder that, as TS Lombard's Oneglia summaries, "the deal is short-term positive for the EU economy and markets, but yet another masterclass in Brussels’s depressing can-kicking."
