Brussels, 31 May 2011
EU Economic governance: a major step forward
The EU and its Member States have taken a series of important decisions that will mean stronger economic and budgetary coordination for the EU as a whole and for the euro area in particular. In this way, an imbalance that has existed between the two parts of Europe's Economic and Monetary Union (EMU) is being rectified. The decisions will ensure that Member States more closely coordinate their economic policies – something the crisis has shown to be essential. As a result, the EU's interdependent economies will be better placed to chart a path to growth and job creation. It is a major step forward.
The new economic governance is based on the three main responses to the crisis:
1. Reinforcing our common economic agenda with closer EU surveillance
2. Safeguarding the stability of the euro area.
In 2010, the EU responded to the sovereign debt crisis by setting up temporary support mechanisms, which will be replaced by the permanent European Stability Mechanism (ESM) in 2013. These support measures are helping to safeguard the financial stability of the euro area. They are conditional on rigorous fiscal consolidation and reform programmes, and are developed in close cooperation with the IMF.
3. Repairing the financial sector.
The EU has established new rules and agencies to address any problems earlier and make sure all financial players are properly regulated and supervised. Further work will be carried out, including the more systematic and rigorous bank stress tests currently taking place. A healthy financial sector is essential to allow businesses and households access to credit.
1. Reinforcing our common economic agenda with closer EU surveillance
A common framework is essential for the EU to tackle its economic challenges and return to a stronger growth path. In the past, the lack of a clear system of economic governance between Member States led to imbalances and lost opportunities, and made the EU more vulnerable when the crisis hit. To ensure that those days are behind us the Commission proposed the Europe 2020 strategy, which was endorsed by the European Council in June 2010. The strategy brings together (1) a common economic agenda and (2) a stronger EU surveillance framework, which should be decided upon and monitored in a synchronised way (3).
1.1 Europe 2020, the Annual Growth Survey and the Euro+ Pact
The Europe 2020 strategy * 1 is the EU's common economic agenda – a plan to move beyond the crisis and boost smart, sustainable and inclusive growth over the next 10 years. It deals both with short-term challenges linked to the crisis and the need for structural reforms and growth-enhancing measures needed to help Europe recover from the crisis and make its economy more resilient to economic shocks in the future.
Europe 2020 is based on a simple and effective delivery mechanism, made up of targets, concrete priority actions and monitoring. It consists of:
1.2. Tighter EU surveillance of economic and fiscal policies
Over the past few years, the EU has not been able to respect the goals it set itself on economic and fiscal policies, partly because of a surveillance mechanism that was not stringent enough. To address this, on 29 September 2010 the Commission presented six legislative proposals (the so-called Six-Pack11). The European Parliament and the Council are expected to give their final agreement to the package in June 2011. The package has three main objectives:
- 1st objective: Stronger preventive action through a reinforced Stability and Growth Pact
Member States must avoid excessive public deficits (beyond 3% of GDP) and excessive debt (beyond 60% of GDP), so as not to put fiscal sustainability at risk. These rules are enshrined in the Treaties and detailed in the Stability and Growth Pact* (SGP).
This is achieved both through surveillance of national budgets and surveillance and coordination of economic policies (based on Article 121 of the Treaty). To this effect, each year Member States set out the structural reforms and efforts needed to achieve fiscal sustainability in their Stability or Convergence Programmes* (SCP).
The new governance system introduces three key changes:
When Member States do not respect the thresholds laid down in the Treaties, the Excessive Deficit Procedure* (EDP) is triggered. However, the current fiscal situation in almost all Member States, and the sovereign debt problems in some, show that the existing EDP was not effective. The Commission has proposed giving teeth to the SGP through better enforcement and the ability to fine Member States (as outlined above). The two key changes are:
- 3rd objective: reducing macro-economic and competitiveness imbalances.
Over the past decade, Member States have made divergent economic choices, leading to competitiveness gaps and to major macroeconomic imbalances within the EU. A new surveillance mechanism will be set up to identify and correct such issues much earlier. It will rely on the following main elements:
1.3. The European Semester
In the past, the EU Institutions looked at economic policy in the spring and fiscal frameworks in the autumn, with the implementation by Member States of commitments made at EU level only reviewed retrospectively. Basically, we decided on economic objectives without necessarily knowing how much money we could mobilise.
From now on, Member States and the Commission will discuss structural reforms, growth-enhancing measures and fiscal surveillance at the same time. These discussions will occur at EU level every year from January to June (the European Semester*12 actually refers to the first semester of each year). In this way, Europe will ensure consistency between economic decisions and budgetary constraints so as to reinforce their effectiveness and improve delivery at national level. The extra commitments taken under the Euro+ Pact will also be fully integrated into this new process.
How will it work?
2. Safeguarding the stability of the euro area
The economic crisis has put great pressure on public finances, increasing levels of deficits and public debt in all Member States. Three non-euro area Member States have been granted financial assistance by the EU (through the balance of payments mechanism), IMF and World Bank, in exchange for agreeing to implement programmes of fiscal consolidation and structural reforms. The first was agreed with Hungary, which received disbursements of €5.5bn between October 2008 and November 2010. A second programme was approved for Latvia in January 2009, in exchange for assistance of up to €7.5bn. And a third programme was agreed with Romania for €5bn in May 2009. The Romanian and Latvian programmes are currently ongoing.
The evolution of sovereign debt has become a matter of serious concern since 2010 and has closed access for some euro area Member States to sustainable sovereign debt refinancing on the market.
To guarantee the stability of the euro area as a whole and assist individual Member States in financial difficulties and/or under serious market pressure, temporary mechanisms have been set up as a backstop of last resort. An agreement has also been reached on a permanent mechanism to be put in place as of 1 July, 2013.
Financial assistance can be provided to a euro area Member State which requests it, subject to strong conditionality reflected in an economic adjustment programme to be negotiated by the Commission and the International Monetary Fund (IMF), in liaison with the European Central Bank (ECB). With such mechanisms, the EU has the capacity to act to defend the euro, even in the most stressed scenarios. They are a clear reflection of the common interest and solidarity within the euro area, as well as the individual responsibility of each Member State before its peers.
- Mechanism of bilateral loans (for Greece). An ad hoc mechanism was set up on 2 May 2010 to face the imminent threat of Greek insolvency. The euro area Member States agreed to provide, together with the IMF, €110bn of financial assistance to Greece in the form of bilateral loans, with specific interest rates, for a period of three years. These loans were made conditional on a strict fiscal consolidation programme, and were discussed with the Commission, the ECB and the IMF. The Commission monitors progress through quarterly missions and reports to Finance Ministers.
The agreement of 11 March 2011 aligned the maturities of both the future and already disbursed tranches of the loans to Greece with those of the loan to Ireland (seven-and-a-half years on average). Furthermore, it was decided to reduce the pricing of both the future and already disbursed tranches of the loans of the Greek facility by 100 basis points.
- Temporary mechanisms worth up to €500bn (2010–2013). In the face of persistent pressure on the sovereign debt markets, the euro area Member States and the Commission decided on 10 May 2010 to set up two temporary financial backstop mechanisms worth up to €500bn to support any other euro area countries which could need financial support. These are the European Financial Stabilisation Mechanism* (EFSM), based on guarantees from the Community budget up to €60bn; and the European Financial Stability Facility* (EFSF), an inter-governmental body providing up to €440bn in guarantees from the euro area Member States. The IMF decided to complement these mechanisms with a potential financial support to euro area countries of up to €250bn.
In November 2010, Ireland requested €85bn in assistance from these newly set up mechanisms, following a sharp deterioration in its fiscal position due to extraordinary banking problems which came on top of the impact of the recession. A programme was negotiated by the Commission, the IMF and the ECB. The United Kingdom, Denmark and Sweden decided to complement this assistance mechanism with bilateral loans14.
In light of the Irish experience and in order to face any other request before 2013, the 24-25 March European Council further improved key elements of these temporary mechanisms. The pricing of the EFSF's loans (and subsequently those of the EFSM) has been lowered to better take into account the debt sustainability of the assisted countries, while remaining above the funding costs of the facility, in line with the IMF’s pricing principles. The EFSF's scope of activities has also been made more flexible: it may, as an exception, intervene in the primary debt market (i.e. buying newly issued sovereign bonds) in the context of a programme with strict conditionality. Finally, the agreed lending capacity of the EFSF of €440bn will be made fully effective, as recommended by the Commission. The amendments to the EFSF legal agreement will be prepared so as to allow national parliamentary procedures to be completed by the end of June 2011, in full respect of national constitutional requirements.
In May 2011, financial assistance of €78bn was also granted to Portugal to enable the country to deal with its financing difficulties. Two thirds of the assistance will come from EU sources: €26bn from the EFSF and €26bn from the EFSM, with the remaining €26bn provided by the IMF. The assistance will be disbursed over three years, conditional on the outcome of quarterly assessments of Portugal's implementation of the agreed programme, comprising an ambitious fiscal adjustment, a wide range of reforms to enhance growth and competitiveness and measures to reinforce the stability of the financial sector.
- European Stability Mechanism* (as of 1 July, 2013). Last autumn, euro area Member States decided to set up a permanent mechanism, enshrined in the Treaty, as a structural response to any future request for financial assistance beyond 2013.
The European Stability Mechanism15 (ESM) will provide a permanent crisis resolution framework and will assume the role of both the European Financial Stability Facility (EFSF) and the European Financial Stabilisation Mechanism (EFSM) in providing external financial assistance to euro area Member States from 1 July, 2013. Access to ESM financial assistance will be provided on the basis of strict policy conditionality under a macro-economic adjustment programme and a rigorous analysis of public-debt sustainability, which will be conducted by the Commission together with the IMF and in liaison with the ECB. The beneficiary Member State will be required to put in place an appropriate form of private-sector involvement, according to the specific circumstances and in a manner fully consistent with IMF practices. Non-euro area Member States may decide to participate in operations conducted by the ESM on an ad hoc basis (as it is the case now with Ireland).
The terms of the ESM, including its governance, capital structure and repartition, location, instruments and IMF involvement, were agreed by the euro area summit on 11 March and confirmed by the European Council on 24-25 March. The ESM will have an effective lending capacity of €500bn (a total subscribed capital of €700bn, from which €80bn will be in the form of paid-in capital and €620bn in a combination of committed callable capital and of guarantees from euro area Member States).
The Treaty on the Functioning of the EU (Article 136) will be amended to set up the ESM. After the Commission and the European Parliament gave their positive opinions, the European Council agreed on this change in February and March 2011, paving the way for national ratifications.
3. Repairing the financial sector
Since the outbreak of the financial crisis in 2008, EU action has focused on filling in the gaps in financial sector regulation and strengthening the supervision of this sector, with a view to improving stability, transparency and confidence.
In parallel, work is ongoing to ensure the viability of the banking sector and overcome the crisis.
GLOSSARY: GUIDE TO KEY ECONOMIC GOVERNANCE TERMS
Annual Growth Survey (AGS) – Presented by the Commission at the start of each year, the AGS sets out the economic priorities for the EU to boost growth and jobs for the next twelve months. The AGS is the basis for the Spring European Council to issue its guidance, which is then translated into national plans by April/May. The presentation of the AGS also marks the start of the European Semester.
Euro+ Pact – The Euro+ Pact is a complementary agenda to the AGS, setting out additional reforms to which the euro area Member States have committed, and to which other Member States can sign up if they wish (Bulgaria, Denmark, Latvia, Lithuania, Poland and Romania have done so). The Pact, agreed in March 2011, focuses on competitiveness, employment, sustainability of public finances and reinforcing financial stability.
Europe 2020 – This is the EU's common economic agenda: a ten-year reform strategy to boost growth and job creation while promoting social inclusion and combating climate change. Agreed in March 2010, the strategy sets out five levers for growth and five targets to be achieved by 2020 in relation to employment, research & innovation, energy, education and poverty reduction.
European Financial Stability Facility (EFSF) – Established in May 2010, the EFSF is an inter-governmental body able to lend up to €440bn to euro area countries in need of financial support. The euro area Member States themselves provide the loan guarantees. The EFSF will be replaced as from 1 July, 2013 by the ESM.
European Financial Stabilisation Mechanism (EFSM) – Also set up in May 2010, the EFSM is available to provide loans of up to €60bn to euro area Member States in need of financial support. The EFSM is guaranteed by the Community budget, without being effectively paid from the budget itself. The EFSM will also be replaced by the ESM as of 1 July, 2013.
European Stability Mechanism (ESM) – The EU's permanent crisis resolution mechanism will be operational from 1 July, 2013. It will replace the EFSM and the EFSF as the vehicle through which financial assistance will be provided to euro area Member States in need. Assistance will be on the basis of strict policy conditionality and tied to a macro-economic adjustment programme. The terms of the ESM were agreed at the March 2011 European Council. It will have an effective lending capacity of €500bn. To allow for the establishment of the ESM, a change has been agreed to Article 136 of the Treaty on the Functioning of the EU.
European Semester – Starting in 2011, the first half of each year will see a cycle of intensive policy coordination between the EU Institutions and the 27 Member States on both the economic agenda and budgetary surveillance. This is a key element of the enhanced economic governance. The Semester kicks off in January with the presentation by the Commission of the Annual Growth Survey, which sets out the priorities for the EU in terms of economic reform and fiscal consolidation. These priorities are then discussed and endorsed by the March European Council. In April, Member States submit their National Reform Programmes and their Stability or Convergence Programmes to the Commission and to their peers. The Commission then issues recommendations on these programmes, which are endorsed by the June European Council and formally adopted by the Council in July. Member States take this guidance into account when they draw up their budgets, which are debated in national parliaments in the usual way in the second half of the year – ensuring that this process includes a European dimension for the very first time.
Excessive Deficit Procedure (EDP) – Member States must avoid excessive public deficits (beyond 3% of GDP) and excessive debt (beyond 60% of GDP). The Commission has proposed to strengthen the existing Excessive Deficit Procedure, which is aimed at preventing governments from breaching these thresholds. When a Member State does not respect the thresholds, the Council decides on the basis of a recommendation by the Commission to launch an Excessive Deficit Procedure. Euro area countries placed in EDP will be requested to make a non-interest-bearing deposit worth 0.2% of their GDP and to take a course of corrective action as recommended by the Council. If a country fails to comply with the recommendation, the deposit will be converted into a fine.
Excessive Imbalance Procedure (EIP) – A key element of the EU's new economic governance is the emphasis on tracking and correcting macro-economic and competitiveness imbalances, particularly within the euro area. Using a scoreboard of around ten indicators, the Commission will detect imbalances emerging in different parts of the economy. On a recommendation from the Commission, the Council can open an Excessive Imbalance Procedure against a Member State in which imbalances exist or are at risk of emerging. For euro area countries, a failure to correct imbalances in accordance with an agreed roadmap and within a specified deadline can lead to the imposition of fines of 0.1% of GDP.
National Reform Programme (NRP) – All Member States submit in April/May an NRP to the Commission following the March European Council. This sets out the economic reforms and growth-enhancing measures to be passed over the coming year and beyond to move the Member State in question towards the targets it has signed up to in the context of Europe 2020. Member States present their NRPs together with their Stability and Convergence Programmes (which focus on fiscal consolidation). The Commission bases its country recommendations on both plans.
Stability or Convergence Programmes (SCP) – In the weeks following the March European Council, Member States submit to the Commission their plans for sound public finances and fiscal sustainability. For euro area countries, these are called Stability Programmes; for other Member States, Convergence Programmes. The Commission assesses these programmes together with Member States' National Reform Programmes over the course of April/May. Its recommendations are endorsed by the June European Council and formally approved by the Council shortly afterwards.
Stability and Growth Pact (SGP) – The Stability and Growth Pact is the framework through which the EU ensures the fiscal sustainability of all 27 Member States and of the euro area in particular. The reforms to the EU's economic governance that will be formally agreed in June 2011 will make the SGP clearer, stronger and more effective, at both the prevention and enforcement stages. Public debt and public deficit criteria will be placed on an equal footing for the first time. Member States will be required to make significant progress towards medium-term budgetary objectives and expenditure growth will have to be kept in line with GDP growth. The Commission will recommend fines of 0.2% of GDP for euro area countries which fail to take corrective action to achieve these objectives within an agreed timeframe. These fines will apply unless a qualified majority of Member States votes against them.
* all items referred with * are explained in the glossary attached to this MEMO