The European debt brake is back: In the coming years, regulations from Brussels will force the governments of some of the largest EU states to make savings. On Wednesday, the European Commission initiated proceedings against member states with high levels of debt and budget deficits for the first time since the beginning of the pandemic.
This gradually reinstates the ceilings on public finances in the EU after they had been suspended for almost four years. EU Economic Commissioner Paolo Gentiloni spoke of a “new cycle” that European economic and financial policy is now entering.
Tough conflicts are imminent between Paris and Brussels
This time, the focus is primarily on France, which, in the Commission’s view, urgently needs to get its budget in order. Regardless of the outcome of the parliamentary elections at the end of June, tough disputes between Paris and Brussels are expected in the coming years.
In the spring, the EU states agreed on new stability rules that were to apply from 2025. On the one hand, they give the EU states more leeway in reducing their deficits and, on the other hand – unlike before – they are to be enforced more strictly. With the new deficit procedures, these requirements are facing their first reality check. There is still a limit of 60 percent of economic output for total debt, and new debt may not exceed three percent. France is indebted to more than 110 percent of its economic output and expects a budget deficit of more than five percent this year.
Neither President Emmanuel Macron nor the far-right Rassemblement National party or the left-wing camp, which are competing for power in the National Assembly, can afford expensive election promises. Macron unexpectedly called early parliamentary elections on the evening of the European elections, which put France under pressure on the financial markets. Interest rates on French national debt and insurance premiums for the country’s default had risen sharply.
Violations of EU austerity measures could result in fines
A new debt crisis is not imminent, says Daniel Kral, economist at the analysis firm Oxford Economics. But it is clear that the markets are back as judges of public finances. And: “A collision with Brussels over the fiscal policy course seems inevitable,” says Kral. According to economists at the Brussels think tank Bruegel, France will have to reduce its public spending by around 0.54 percent of gross domestic product per year over the next seven years, which would correspond to around 15.7 billion euros in 2024. Violations of the EU austerity targets could result in fines.
Other capitals are also facing similar disputes. In addition to France, the Commission has certified that Italy, Poland, Belgium, Hungary, Slovakia and Malta have “excessive deficits”. This ruling is based on detailed country analyses that the authority regularly submits and is the first step towards excessive deficit procedures. The Council of Member States is expected to decide on these in mid-July.
The Commission will then present recommendations on reducing deficits in November. In light of the new EU debt rules, “we expect Member States to present national fiscal structural plans that reduce debt and deficits and take today’s recommendations into account,” said Commission Vice-President Valdis Dombrovskis.
Italy is the second major eurozone country under special observation. Rome has also been operating with annual new debt well above three percent since 2020. The Commission expects an Italian budget deficit of 4.4 percent this year and 4.7 percent next year. Total debt is almost 140 percent of economic output, more than twice the prescribed level. Italy is vulnerable, the Commission warns in its report, “mainly because of high public debt and weak productivity growth,” against the backdrop of a fragile labor market and “some remaining weaknesses in the financial sector with cross-border significance.”
Germany is spared an excessive deficit procedure
The Commission also criticized Germany, which is expected to avoid an excessive deficit procedure with new debt of 1.6 percent – mainly because of a lack of investment. “The budget consolidation is likely to weigh on domestic demand and possibly affect public investment,” the Commission writes.
Germany’s vulnerability is due to a “significant savings/investment gap”. Investment needs have increased, “especially in relation to public investment at regional level and corporate investment in general”. Combined with weakening domestic demand, this is contributing to high current account surpluses, which are likely to increase further this year and next. This will have negative consequences for the rest of the euro area, writes the Commission.