Public finances in Member States in 2004

In the public finance field in the Union in 2004, budgetary performances differed significantly between Member States. While most Scandinavian countries had a balanced budget, budgetary developments in a number of countries were a matter of concern. In this communication the Commission reviews the current public finance position in Member States. It looks at the difficulties encountered and comes up with possible solutions.

ACT

Communication from the Commission to the Council and the European Parliament: Public finances in EMU - 2004 [COM(2004)425 final - Not published in the Official Journal].

SUMMARY

The Commission analyses public finances in European and Monetary Union (EMU) in 2004 and emphasises the need to strengthen the economic governance framework in the Union. It notes more frequent use of the excessive deficit procedure and refers to the strains that are a source of uncertainty in implementing the budgetary surveillance framework, notably because of the divergent interpretation of the provisions of the Treaty and the stability and growth pact by the Community institutions. It proposes an improved analysis of budgetary developments. It also stresses that budgetary discipline and economic growth are mutually compatible objectives. It analyses the link between long-term fiscal and growth policies with a view to improving the quality of public finances.

Review of the current situation

Slower growth is contributing to budget deficits throughout the European Union (EU). Enlargement of the Union in 2004 led to growing disparities in the budgetary performances of Member States. The most significant deficits are those of Germany and France. Given their size, both countries affect the overall outcome for the euro area. The Commission is concerned about the public finance situation in Italy given its high debt-to-GDP ratio but also about the deterioration in actual balances in several countries outside the euro area, including Poland and the United Kingdom. However, it notes the soundness of public finances in Belgium, Spain, Finland, Ireland and Luxembourg. Outside the euro area, Denmark, Estonia and Sweden maintained surpluses throughout the cyclical slowdown.

The last two years have seen frequent use of the excessive deficit procedure. In 2003 Germany, France and Portugal were in an excessive deficit position. In the case of Germany and France, the probability of bringing the deficits below 3 % of GDP in 2004 was very low in the light of the draft budgets submitted for 2003. The Commission therefore moved forward with the excessive deficit procedure with the aim of urging these two countries to correct their deficits at least by 2005. In 2004 the Commission also started the excessive deficit procedure for Greece, the Netherlands and the United Kingdom, which registered deficits above 3 % of GDP in 2003. On the basis of its forecasts, the Commission recommended that an "early warning" be sent to Italy given the risk that it would breach the 3 % reference value in 2004. The procedure was also started for several new Member States following their accession to the EU. Recommendations were addressed to them with a view to helping them pursue a credible mulitiannual adjustment path.

In the immediate future, in spite of an improving growth outlook, the Commission considers that budgetary prospects for 2004 and 2005 are not very promising and that achieving sound public finances will take time. The deficit in Germany and France is projected by the Commission to remain above 3 % of GDP in 2004. The two Member States are committed to bringing down the deficit to below 3 % of GDP in 2005. Greece, Italy, the Netherlands and Portugal could also see their deficits breach the 3 % threshold if no corrective measures are taken. The budgetary situation in most of the new Member States is expected to improve over the next two years.

Unfortunately, a close-to-balance position will not be reached by most Member States, including Germany, France, Portugal and the United Kingdom, by 2007 (0.7 % of GDP for the euro area). These countries do not have an adequate safety margin to prevent a breach of the 3 %- of-GDP reference value in the event of adverse economic conditions. The Commission considers that the medium-term objectives of some Member States are based on overly optimistic growth assumptions.

The poor implementation record for the stability and convergence programmes is hampering achievement of the Lisbon objectives for making the EU the most competitive and most dynamic economy in the world. It is vital that Member States reach budgetary positions which ensure that the automatic stabilisers work freely and mitigate the impact of population ageing on the sustainability of public finances. As economic conditions improve, efforts will be needed to improve the underlying budgetary positions: the difficulties experienced by certain Member States in complying with the Treaty requirements in 2002 and 2003 reflect the fact that they did not carry out enough fiscal adjustment during the good economic times in 1999 and 2000.

Overcoming current difficulties

The Commission notes tensions in the implementation of the procedures laid down in the Treaty and the stability and growth pact (SGP) as regards budgetary surveillance, notably on account of the divergent application of the SGP by the Community institutions. In February 2002, for instance, the Commission recommended that the Council address an "early warning" to Germany and Portugal. The Council did not follow the Commission's proposals on account of the commitments made by those countries. Similarly, the Council did not follow in 2003 the Commission's recommendations regarding Germany and France which extended by one year the deadline for correcting the excessive deficit situation and which entailed triggering the following stages in the procedure.

The Commission has announced a strategy aimed at seeking legal clarity on the provisions of the Treaty and the SGP, pursuing budgetary surveillance and strengthening economic governance. Accordingly, at the end of January 2004 it asked the European Court of Justice to annul the decisions taken by the Council and the conclusions adopted at its November meeting. The Commission is pursuing budgetary surveillance in accordance with the provisions of the Treaty and the SGP. This involves assessing the 2003 updates of the stability and convergence programmes and preparing draft opinions for the Council. It is updating the broad economic policy guidelines (BEPGs), including the country-specific recommendations for certain Member States.

The Commission considers that the temporary slippages affecting budgetary positions must be identified more quickly. The Report on Public Finances in EMU - 2004 highlights four areas where progress has been made in analysing budgetary developments:

• the role of one-off measures. "One-off" measures taken by governments are becoming a frequent and sizeable feature of budgetary policies in the EU. In the Commission's view, it is important to take account of such measures and the reasons behind them in the budgetary surveillance process. It would like to see greater transparency of budget measures and better reporting of them by Member States, including in the stability and growth programmes;
• the use of cyclically adjusted budget balances. At present, a common methodology which provides figures for cyclically adjusted budget balances (CABs) is used to disentangle changes in the budget which reflect the economic cycle from those which do not, the latter reflecting measures decided by policymakers. The Commission proposes excluding the component of the change attributable to unexpected changes in potential growth in order to correct the fiscal adjustment measures made at the level of Member States;
• the assessment of the long-term sustainability of public finances. Budgetary surveillance includes an assessment of the long-term sustainability of public finances on the basis of the updated stability and convergence programmes. The Commission is stepping up the quantitative analysis of the results obtained, thereby giving the assessment a higher information value. It notes that the risks to long-term sustainability are most serious in five countries (Germany, Belgium, France, Greece and Italy) and that two countries (Netherlands and United Kingdom) face medium-term difficulties. Spain and Portugal envisage difficulties over the long-term projections for pension expenditures. Six countries (Austria, Denmark, Finland, Italy, Luxembourg and Sweden) seem to be well placed to meet the costs of an ageing society on the basis of current policies;
• the consideration of contingent liabilities. To obtain a comprehensive picture of the sustainability of public finances, liabilities other than those included in the Maastricht definition of gross debt should be considered. "Contingent liabilities" correspond to government obligations that materialise only when particular events occur, and the stock of such liabilities is relatively high in the new Member States. Given the differing national situations and trends in the EU, the Commission considers that improved disclosure and monitoring of contingent liabilities would help to strengthen budgetary discipline in the Union.

There have been criticisms that the EU budgetary surveillance framework focuses too much on disciplinary aspects and so is not growth-friendly. The Commission concludes that budgetary discipline does not rule out economic growth. Budgetary discipline and sound public finances contribute to a macroeconomic environment that fosters growth, and the fiscal framework prevents protracted deficits that may have an impact on future income. The Commission's analysis suggests that the budgetary adjustment in the 1990s induced by the EU fiscal framework resulted in growth of limited duration and magnitude but laid the foundations for better growth prospects. In the absence of the framework, the budget deficits would have crowded out private investment and further reduced potential growth compared with current figures.

The Commission highlights the need to strengthen economic governance in the EU. The framework which applies to the conduct of national fiscal policies and the processes underlying the coordination of economic policies in the EU need to be reassessed. For instance, the Treaty rules on public finances contribute to growth and allow room for proper implementation of the Lisbon strategy. However, the BEPGs could assume a more prominent role in economic policy coordination by providing better fiscal guidance to Member States. The Commission again stresses the importance of improving the interpretation of the fiscal rules in order to take debt developments in Member States into account. Lastly, the Commission recalls the advantages of clarifying the respective roles of the Council and the Commission in implementing the Treaty instruments. It also emphasises the importance of an improved dialogue between all the actors concerned at both national and Community level.

Since 2000 the Commission has produced an annual report on public finances in the European Union. It also adopts communications on the subject.

RELATED ACTS

Commission Communication to the Council and the European Parliament - Public finances in EMU - 2003 [COM(2003)283 final - Not published in the Official Journal] The European Commission recommends establishing a coherent medium-term strategy to tackle the problem of growing budget imbalances and stimulate growth.

Commission Communication to the Council and the European Parliament - Public finances in EMU - 2002 [COM(2002)209 final - Not published in the Official Journal] The Commission takes stock of the trend in budgetary policies. There are economic situations to be faced up to while the budgetary framework for the Economic and Monetary Union has to be improved. The Commission underscores the importance of the early warning procedure. To ensure that the stability and growth pact is credible, the Commission believes that its objectives must be attained, while the long-term viability of public finances must be secured. In addition, the quality of public expenditure must be guaranteed and enlargement must be prepared.

Commission Communication to the Council and the European Parliament - Public finances in EMU - 2001 [COM(2001)355 final - Not published in the Official Journal] This communication analyses the budgetary results of the Member States in 2000 and considers the short- and medium-term prospects. The budgetary policy debate is influenced by a variety of factors, in particular the stability and growth pact objective of attaining a budget position close to balance or in surplus, The importance of a budgetary policy that ensures an appropriate mix of macro-economic policies, the enlargement of the debate to embrace the quality and viability of the public finances, and the need for coordination on budget issues. Lastly the Commission sets out in detail the path to be followed, that is to say closer coordination on budgetary matters.

See also

For further information, see the website of the Directorate-General for Economic and Financial Affairs:

• Public finances in the European Union: reports from 2000

Last updated: 07.10.2005