SPEECH/02/506

Pedro Solbes

Member of the European Commission responsible for Economic and Financial Affairs

Economic situation and budgetary developments : Implementation of the Stability and Growth Pact

Plenary Session, European Parliament

Strasbourg, 21 October 2002

Let me first say that this is a very timely moment to discuss the budgetary policy framework in our Economic and Monetary Union. Growth prospects and budgetary positions are worse than expected only some months ago. This poses challenges to budgetary and economic policy coordination. It is therefore a good moment to discuss whether the EU policy framework is adequate and how it has to be implemented.

Let me start by expressing my firm conviction that the Stability and Growth Pact makes up for an essential rule-based framework within the institutional setting of EMU. I believe that the Pact provides the Member States with rigurous, as well as flexible, rules to meet the short, medium and long-term policy challenges the Union is facing.

The Commission has reiterated during the last four years that sticking to the close-to-balance rule is the best way for fiscal policy to fully play its stabilising role over the cycle.

Indeed, we have to put higher emphasis on cyclically adjusted balances to analyse fiscal positions. The Commission has increasingly been working in this line. By doing this, it will be easier to avoid expansionary fiscal policies when the economy is booming. As past and recent history reveals, this is a pre-requisite to avoid fiscal tightening in bad times.

The Pact also gives a framework to meet the challenges of fiscal policy in the medium term. We all agree that tax and expenditure reforms are paramount to enhance potential growth across the EU. The Commission has stressed that a correct interpretation of the rules of the Pact provides good guidance to assess whether such reforms are actually improving the quality of public finances in a stable way. It would not be politically sound, nor economically beneficial in the long run for example to lower the tax burden today just to have to increase taxes in a couple of years time to finance the deficit.

Finally, the Pact has also proven to be capable to encompass long-run challenges, in particular those related to ageing populations. Some of the provisions of the Pact, such as the need to implement sound fiscal policies and to run down public debt at fast pace, are necessary conditions to meet this challenge.

A majority of Member States have shared this vision of the Pact and are now in a good position to allow fiscal policy to play its anti-cyclical role at the current economic juncture, when the economic outlook points to a more gradual recovery than foreseen earlier this year. The average growth rate for the euro area in 2002 will be less than 1%. Next year growth could be close to the potential growth rate of the euro area.

At this juncture, lower than expected growth only partly explains the slippage from budgetary targets formulated earlier this year. In a number of countries, overoptimistic projections of revenue and expenditure trends, and policy slippage have also played an important part.

As a result, budget deficits in the euro area will add up to more than 2.0% of GDP this year, against a target of 0.9% of GDP in the last updates of stability programmes.

Against this background, and in line with the vision of the Pact I just have described, we, President Prodi and myself, presented at the end of September a strategy on how to deal with current budgetary challenges.

With a view to strengthening the implementation of the Pact while at the same time taking into account the complexities of economic reality and the effects of the economic cycle, the strategy contains four key elements:

• The 3% of GDP deficit threshold is and remains a binding constraint. Any breaching of the threshold requires swift corrective action of the Member States concerned. It also requires timely activation of the excessive deficit procedure procedures as foreseen in the Treaty and in the Stability and Growth Pact whenever necessary.

• The close-to-balance medium-term objective of the SGP, and the adjustment path towards it, should be interpreted in cyclically adjusted terms. We have now a common methodology in the Union to calculate the cyclically adjusted budgetary positions and we should put it to good use.

• Countries which have not yet reached the close-to-balance objective should achieve as a minimum a 0.5% of GDP per annum reduction in their underlying budgetary position.

• In years with high growth, any pro-cyclical loosening of the budget leading to a violation of the close-to-balance rule should be treated as a failure to abide by the rules of the Stability and Growth Pact. Automatic stabilisers must operate symmetrically over the entire economic cycle, and this implies running surpluses in good times.

These four principles strengthen the implementation of the Stability and Growth Pact by explicitly incorporating the effects of cyclical developments in the process of budgetary surveillance.

I am very satisfied that Eurogroup Ministers two weeks ago in Luxembourg took a similar view and agreed with this proposal.

All countries, including those with deficit positions, have accepted this approach and with the exception of France are striving to implement it as of 2003.

The budgetary situation is particularly acute in four countries that failed to consolidate their finances during the period of strong expansion: Portugal, Germany, France and Italy. Deficits in some of these countries are dangerously close, if not already above, the 3% threshold. I am aware that the adjustment required by these countries in order to reach the close to balance position is substantial. But I also think that making this adjustment is crucial for each country to create sufficient room for automatic stabilisers to play fully and to prepare for the longer-term implications of ageing.

In the case of Portugal, the Commission took a number of important decisions last week in the framework of the excessive deficit procedure. In our Opinion to the Council we conclude that an excessive deficit exists in Portugal.

Indeed, the general government deficit amounted to 4.1% of GDP in 2001, thereby clearly exceeding the reference value of 3% of GDP. Moreover, government debt, rose in 2001 to 55.5% of GDP, albeit still below the 60% reference value.

In 2002, the government adopted supplementary budget consolidation measures in the Spring with a view to bringing the budget deficit to 2.8% of GDP in 2002. They are also ready to adopt additional saving measures this year, if needed, in order to honour this target. This is a very positive development and I do hope that the expected results will be reached. However, at this stage, it is not yet possible to assess whether the deficit would stay below the 3% of GDP reference value in 2002. The Portuguese authorities should implement with resolve all saving measures announced.

There are indications that Germany has overstepped the 3% reference value this year. In France, the planned deficits remain dangerously close to the 3% ceiling and no adjustment effort is foreseen next year. In Italy, leaving aside significant deviation from previous targets, the apparent interruption in the decline of the still very high level of debt is a worrying element.

If such prospects are confirmed either by official notifications or by Commission data, as agreed in the Amsterdam declaration, the Commission will apply with resolve the preventive provisions of the Treaty and the Pact.

At the current critical juncture, this strategy provides the appropriate framework to take into account the effects of cyclical developments on budgetary policy in the short run. It also paves the way to a sustainable improvement of the quality of public finances, which will enhance potential growth in the Union.

These are my thoughts on behalf of the Commission on the economic situation and the budgetary perspectives. And I am delighted to share them with you as representatives of European citizens, as I have done on different occasions in the past years.