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European Commission

Olli Rehn

Vice-President of the European Commission and member of the Commission responsible for Economic and Monetary Affairs and the Euro

2012 European Semester

EP ECON Committee Economic Dialogue, Strasbourg,

11 June 2012

Dear Sharon, honourable Members,

Thank you very much for the invitation to this Economic Dialogue on the package of economic analyses that the Commission adopted on 30 May and to discuss the country-specific recommendations we proposed.

This is the first European Semester that is underpinned by the new framework of reinforced economic governance. The fact that this stronger framework is in place is in good part your achievement.

Implementing sound and solid economic surveillance in this framework is one of our joint contributions to overcoming the ongoing crisis.

Holding the Commission to account in this Economic Dialogue provides for the democratic accountability that is needed in this ongoing process of closer and more intense EU-level policy coordination.

Equally important is your task of holding the Council to account in a later stage of this dialogue. The Council Presidency may be asked to explain differences between the recommendations eventually adopted by the Council and those presented before by the Commission under the so-called "comply or explain" clause of the Six-Pack.

The European Semester is a very profound and thorough exercise of screening the European economy. It reflects our overall economic strategy, which is based on smart consolidation and sustainable growth as set out in the Annual Growth Survey.

As regards public finances, the situation is slowly improving. In 2009 and 2010, fiscal deficits in the European Union were in the order of 6%. By 2011 they had been reduced to around 4%. This year they are expected to be somewhat above 3%, a further welcome improvement.

The stability and convergence programmes of the EU Member States confirm their commitment to stay the course on consolidation. This will mean that on average, fiscal deficits in the European Union will be below 3% in 2013. If confirmed by the concrete budgets for 2013, this should go a long way towards easing market pressures.

We expect the ratio of government debt to GDP to continue to increase this year and reach 93% next year. The stability programmes of euro area Member States are somewhat more ambitious and foresee a level of about 90% in 2013 and a decline thereafter.

This clearly confirms that one of our main priorities – the need for growth friendly consolidation – will remain valid. And we will have to make certain that the necessary consolidation is indeed brought about in as growth-friendly a manner as possible. One important part of that is the need to differentiate the overall consolidation effort across Member States and let automatic stabilisers work in full where that is possible.

On imbalances, Europe is undergoing a difficult, but necessary, adjustment. This applies to both external and internal economic imbalances. The build-up of large current account divergences since 2000 was not sustainable: we have learned this the hard way. They have been gradually narrowing and re-balancing is proceeding.

However, deficit countries still need to achieve surpluses to bring their external debt onto a declining trajectory. This requires further improvements in competitiveness. It must go hand in hand with private sector deleveraging and the consolidation of public finances.

Based on the in-depth reviews, the Commission concluded that Spain and Cyprus are facing very serious imbalances, not least in their financial sectors, which need to be addressed as a matter of urgency.

On Saturday, following the announcement by the Spanish Government, the Eurogroup took decisive action in this regard by agreeing to establish a credit line for Spain for the necessary restructuring and recapitalisation of the country's banking sector; with a safety margin, the loan amount is estimated as summing up to 100 billion euro.

We also concluded that in Hungary, serious imbalances have developed, as can be seen in the large negative net international investment position. In Slovenia, there are serious imbalances in relation to corporate sector deleveraging and banking stability, as well as external competitiveness. Italy faces serious imbalances as its export performance has worsened and it has been losing external competitiveness for a decade. France faces serious imbalances due to the sizeable losses in competitiveness and export performance owing to both cost and non-cost factors.

These persistent losses of competiveness and the weakening of export performance represent serious imbalances which need to be seriously addressed.

Surplus countries are also adjusting and I would like to draw your attention to some very important recommendations which are part of the package regarding these countries. We have a recommendation specifically for the euro area where we point out that an orderly unwinding of intra-euro area macroeconomic imbalances is crucial for sustainable growth and stability in the euro area. We also state that surplus countries can contribute to rebalancing by removing unnecessary regulatory and other constraints on domestic demand, non-tradable activities and investment opportunities.

This is also reflected in individual country-specific recommendations for the euro area Member States. For example, our recommendations for Germany include three key elements that will be important for rebalancing. First, we endorse wage increases in line with productivity, which will support the strengthening of domestic demand. Second, we support the use of fiscal space for increased growth-enhancing spending on education and research. And third, we call for enhancing the participation of women in the labour force through phasing out of fiscal incentives and increasing the availability of full time childcare facilities and all-day schools.

Once Member States follow our recommendations on structural reforms, they will make an important contribution to enhancing the growth outlook for the EU and facilitating job creation. Broad and bold structural reforms can also have a positive confidence effect in the short term.

At EU level, targeted investment in growth can be achieved through a more focused use of EU structural funds. And an increase in the EIB's capital would enhance its lending capacity and thereby provide financing to the real economy.

Conclusion – further steps in economic governance

Over the last two years we have been actively building up the new architecture of economic and monetary union. The European Semester combined with the Six-Pack has been a major step forward. A further step, the two-pack, is on the table. It synchronises further our governance tools. We must implement the governance framework steadily to demonstrate that it can deliver better policy outcomes.

So the past two years have seen an unprecedented strengthening of coordination of economic and fiscal policies at European level. This has been accompanied by a certain degree of risk mutualisation and an expression of solidarity in the form of the support programme for Greece, the EFSF and soon the ESM.

Yet the renewed intensification of the sovereign debt crisis has shown that we need to think beyond these achievements, important as they are. We need to map out the main steps towards full economic union, to complement and strengthen our existing monetary union. Demonstrating the unequivocal political commitment of Member States to the euro will be part of restoring confidence in the euro area.

Yet, there is no single issue movement that alone can provide one convincing single solution to the complicated problems of the complex eurozone. In particular, in order to be able to move towards further mutualisation, we must in parallel further strengthen our stability culture.

We will not be able to overcome our problems by focusing on a joint issuance of debt without simultaneously ensuring fiscal sustainability. Nor will we be able to anchor a stability culture in the eurozone without significantly pooling the burden of adjustment.

As we work to strengthen the EMU, we will have to concentrate on all of these elements, and both of these dimensions. We have reached a situation where more mutualisation of sovereign risk would require more fiscal integration before it could be justified. But at the same time, more fiscal integration would likely involve more explicit transfers of sovereignty. And this may be possible only in the medium term.

Yet already in the short term, more can be done to strengthen the financial sector in Europe – or, as some put it, to establish a financial union to complement the economic and monetary union.

Under the direction of Michel Barnier, the landscape of financial services has profoundly changed. The Commission’s proposals have brought more market players under supervision, raised the stringency of regulation, created European supervisory agencies, and, last week, filled in a major missing piece, the proposal for bank resolution.

The main building blocks towards a financial union could include, at least for larger banks of systemic importance for Europe's macro-financial stability, stronger EU/EA financial supervision, a resolution authority and a single deposit guarantee scheme. The basic point here is the same: the sharing of risk in the guarantee scheme seems difficult to square with decentralised responsibility for supervision.

But any step in the further sharing of risk can only be taken on the condition that it is balanced by provisions to avoid free-riding on the consolidation efforts of others. Considering fiscal integration, the proposal of a Debt Redemption Pact by the German Council of Economic Advisers is no different. It would balance the suggested mutualisation of debt with very strict fiscal rules for the participating member states for a large number of years. To make it rational for all participants to agree to further risk sharing, interests must be balanced out, which would require a fundamental debate about fiscal sovereignty.

All of this will require a profound and wide-ranging process that also takes into account the relevant legal issues, if responsibilities are to be reallocated and shared. This must include a political process to give democratic legitimacy and accountability to further moves in integration.

The sequencing of these developments will soon need to be worked out, including a roadmap and a timetable. But an early confirmation of the steps to be taken will underscore the stability and solidity of the euro, and help to restore confidence even in the short term.

It is now time to move on – to discuss and decide on how to complete the creation of an Economic and Monetary Union 2.0, so that the eurozone will have a solid base for sustainable growth and job creation.

Thank you for your attention.

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