Brussels, 14 February 2012
First Alert Mechanism Report on macroeconomic imbalances in Member States
Why does the EU need a new Macroeconomic Imbalance Procedure?
One key lesson from the crisis has been that more attention needs to be paid to macroeconomic imbalances and divergences in competitiveness between EU countries. In some cases, current account imbalances and divergences in price competitiveness have reached unprecedented and unsustainable levels, and this goes well beyond a natural catching-up process or demographic determinants of the past decade.
This does not imply a lack of surveillance on imbalances in the past. On the contrary, macroeconomic imbalances have been continuously monitored within the context of the EU's Broad Economic Policy Guidelines (BEPG). In addition, there has been a number of country-specific recommendations related to macroeconomic imbalances. However, experience has shown that surveillance must be followed up by proper enforcement given the potential harmful spill-over effects between countries in the EU, and in the euro area in particular. There is thus a clear need for a stronger framework and reinforced governance, including financial disincentives, to ensure that recommendations are appropriately taken into account at national level.
The Macroeconomic Imbalance Procedure (MIP), and the regulation to enforce it, respond to this challenge. The MIP gives the European Commission and the Council of Ministers the possibility to take action before the imbalances reach unstable levels. The new procedure is part of a comprehensive set of rules that entered into force on 13 December 2011, the so-called "six-pack", which reinforces the monitoring and surveillance of fiscal policies as well as macroeconomic policies in all 27 EU Member States (MEMO/11/898). Surveillance of macroeconomic imbalances under the MIP is an integral part of the "European semester", the economic policy cycle that integrates economic, budgetary and structural reform as well as measures to help boost growth (MEMO/11/364).
What is the role of the Alert Mechanism Report (AMR) in the Macroeconomic Imbalance Procedure?
The Alert Mechanism Report (AMR) is the starting point of the new surveillance procedure. It is a "filter" to identify countries and issues for which an in-depth review is deemed necessary. Based on a scoreboard, the European Commission examines economic indicators to identify internal and external imbalances (see following question). There is no automatic or mechanical interpretation of the results of the scoreboard indicators in the Alert Mechanism Report but rather a qualitative assessment. The overall number of breaches of thresholds, the severity of individual breaches as well as the combination of breaches is considered. The assessment also takes into account other relevant information and economic indicators beyond the scoreboard with a view to getting a comprehensive picture. Economic judgement ensures that all pieces of information are put in perspective and become part of a complete analysis.
Based on that, the European Commission has identified Member States that show signs of potential macroeconomic imbalances or face challenges in adjusting to imbalances, and should therefore be looked into in further depth. It is in these in-depth investigations that the causes of the imbalances are analysed in detail with a view to determine whether they are harmful or not. Only after this in-depth analysis will the European Commission propose a recommendation under the preventive or the corrective arm of the Macroeconomic Imbalance Procedure, if appropriate.
On which economic indicators is the scoreboard based?
The scoreboard is made up of ten indicators with a view to monitor external imbalances, competitiveness and internal imbalances, including housing markets and indebtedness. This helps to identify shorter-term rapid deteriorations as well as any longer-term gradual build-up of imbalances. Alert thresholds have been set for each indicator. The scoreboard has been drawn up by the European Commission following consultation with the European Parliament, the Council of Ministers and the European Systemic Risk Board (ESRB). The indicators may evolve over time. Currently, the design of the scoreboard is as follows:
External imbalances and competitiveness
3 year average of the current account balance as a percentage of GDP, with a threshold of +6% and - 4% of GDP;
net international investment position (NIIP) as a percentage of GDP, with a threshold of -35%; the NIIP shows the difference between a country's external financial assets and its external financial liabilities;
5 year percentage change of export market shares measured in values, with a threshold of -6%;
3 year percentage change in nominal unit labour cost (ULC), with thresholds of +9% for euro area countries and +12% for non-euro area countries;
3 year percentage change of the real effective exchange rates (REER) based on HICP deflators, relative to 35 other industrial countries, with thresholds of -/+5% for euro-area countries and -/+11% for non-euro-area countries; the REER shows price competitiveness relative to the main trading partners.
private sector debt as a percentage of GDP with a threshold of 160%;
private sector credit flow as a percentage of GDP with a threshold of 15%;
year-on-year changes in deflated house prices, with a threshold of 6%;
public sector debt as a percentage of GDP with a threshold of 60%;
3-year average of unemployment rate, with a threshold of 10%.
In the scoreboard, there is a threshold of -4% of GDP for deficits and +6% of GDP for surpluses. Is this in line with the symmetric approach outlined in the legislation?
Surveillance covers both deficits and surpluses. However, the risks are obviously higher for current account deficits than for current account surpluses, because the former raises concerns about the sustainability of the external debt of a country. Large and persistent current account deficits are especially worrying if they are combined with sustained losses of cost competitiveness and export market shares.
Which countries are identified for further review in the Alert Mechanism Report?
Based on the economic analysis and the scoreboard for 2010, the European Commission considers that 12 EU Member States warrant an in-depth review. This reflects the fact that this is the first application of the procedure and that Member States have to cater for previously accumulated imbalances. The European Commission considers that the risks of imbalances in the following countries warrant further investigation: Belgium, Bulgaria, Denmark, Spain, France, Italy, Cyprus, Hungary, Slovenia, Finland, Sweden and the UK.
Among the reasons for calling for in-depth analysis on these twelve countries are the following elements:
Belgium: important loss in export market shares, going hand in hand with deterioration in the current account balance and declining cost competitiveness. The level of gross private sector debt should be seen in conjunction with high levels of public debt.
Bulgaria: very fast accumulation of both external and internal imbalances but now the country is experiencing rapid and sizeable corrections. As the levels of accumulated imbalances are still high, the prospects for further adjustment require a closer examination.
Denmark: the pre-crisis housing boom, which started to be corrected in 2007, was associated with rapid credit growth and a surge of private sector debt, in particular in the household sector. While credit and house prices have partially adjusted in recent years, the stock of private sector debt remains very high.
Spain: is currently going through an adjustment period, following the build-up of large external and internal imbalances during the extended housing and credit boom.
France: there has been a gradual deterioration of the trade balance, and this is reflected in a deterioration of the current account balance and important losses in export market shares.
Italy: significant deterioration in competitiveness since the mid-1990s which is also seen through the persistent losses of export market shares. While private sector indebtedness is relatively contained, the level of public debt is a concern, especially given the weak growth performance and structural weaknesses.
Cyprus: wide-ranging challenges as regards both the external and internal side. The Cypriot economy combines persistent current account deficits and losses in export market shares with high private sector indebtedness.
Hungary: a sharp adjustment of large imbalances has taken place. The levels of indebtedness, particularly of the public sector but also of the private one, continue to be high. Also, the level of external indebtedness is the highest in the EU.
Slovenia: fast accumulation of internal imbalances with high growth in unit labour costs, private sector credit and house prices. The highly leveraged banking sector is under considerable strain as the economy is now in the early stages of a difficult deleveraging process.
Finland: important loss in export market shares. The level of private sector indebtedness has been steadily increasing during the last decade, driven to a large extent by increasing mortgages.
Sweden: increasing household indebtedness, which is now at high levels despite recent slower credit growth. This reflects very strong increases in house prices over the last fifteen years which have started to stabilise only recently.
UK: important loss in export market shares over the last decade, despite some recent stabilisation. The high level of private debt should be seen in conjunction with a weak public finance situation. The household debt largely reflects mortgages in a context of high accumulated increases in house prices.
What about the Member States not mentioned above?
The Report concludes that the following countries do not require a further in-depth review at this point in time: the Czech Republic, Germany, Estonia, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Austria, Poland, and Slovakia. However, for these countries, there will be recommendations on fiscal and macroeconomic policies within the scope of the European Semester.
Countries subject to the EU's financial assistance programme are not assessed in the Alert Mechanism Report as they are already subject to enhanced economic surveillance. This concerns Greece, Ireland, Portugal and Romania.
What are the next steps following the Alert Mechanism Report?
The conclusions of the Alert Mechanism Report will be discussed in the Eurogroup of euro area Finance Ministers and in the EU's Council of Economic and Finance Ministers. The European Commission is also looking forward to the contribution of the European Parliament and key stakeholders. Taking their reactions into account, the European Commission will prepare country-specific in-depth reviews. The reviews will provide the analytical basis for potential recommendations to be addressed to Member States under the preventive or corrective arm of the new procedure. However, an in-depth-review does not automatically lead to a recommendation. As the following graph shows, the Commission's in-depth analysis could result in one of three different scenarios:
Overview of the Macroeconomic Imbalance Procedure
if the situation is considered "unproblematic", the European Commission proposes that no further steps are necessary under the Macroeconomic Imbalance Procedure.
if the European Commission considers that there could be a macroeconomic imbalance, it will come forward with a recommendation to the Member State concerned to correct the imbalance or prevent an imbalance from occurring. These would be presented in the context of the European Semester (May/June).
if the degree of the macroeconomic imbalances is considered severe or may jeopardise the proper functioning of the Economic and Monetary Union, the European Commission can recommend to the Council of Ministers to place the Member State under an Excessive Imbalance Procedure (EIP), within the scope of the corrective arm of the Macroeconomic Imbalance Procedure. In this case, once the Council of Ministers has adopted its recommendation, the Member State concerned will have to submit a 'corrective action plan' with a clear roadmap and deadlines for implementing adequate measures. Surveillance will be stepped up by the Commission on the basis of regular progress reports drawn up by the Member State concerned. While the preventive arm of the Macroeconomic Imbalance Procedure is aligned with the European semester, the corrective arm can follow a different calendar.
Will any sanctions be imposed?
Euro area Member States are subject to a new means of enforcement under the Excessive Imbalance Procedure. It consists of a two-step approach whereby an interest-bearing deposit can be imposed if the Member State concerned has failed to comply. If they fail to comply for a second time, this interest-bearing deposit can be converted into a fine (of up to 0.1% of GDP). A sanction can also be imposed for failing twice to submit a sufficient corrective action plan. Sanctions are decided by reverse qualified majority voting (ie. they are approved unless a majority of Member States votes against, thereby making the decision semi-automatic).
What is the legal basis of the Macroeconomic Imbalance Procedure?
The Macroeconomic Imbalance Procedure is based on two regulations. The first (Regulation 1176/2011) sets out the details of the new surveillance procedure and covers all 27 Member States. The second (Regulation 1174/2011) reinforces enforcement, including the possibility of sanctions, and only applies to euro area Member States.
The Alert Mechanism Report is published annually, but the macroeconomic situation in a Member State might deteriorate rapidly within a year. How will the European Commission ensure that the scoreboard can pick up these deteriorating developments quickly enough?
In addition to the European Commission's annual Alert Mechanism Report on macroeconomic imbalances, continuous monitoring of the macroeconomic situation in Member States takes place as part of the European semester. The Commission's spring and autumn forecasts, for example, are also important steps to assess recent trends and risks in macroeconomic developments. If potentially problematic macroeconomic imbalances arise, an in-depth review can be initiated at any time.
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