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EC: Now Is Not the Time To Follow Rules

Published on , , Twitter: @euinside
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The crisis is officially over, budget policy no longer matters, rules do not matter during election time. Those are the messages from this year’s European semester, the culmination of which was the presentation of the country-specific recommendations on May 18th. At that time, the European Commission showed once again what it means for it to be political – it bent the rules so that they could be stepped over, which practically reduced the European semester to a meaningless exercise. And the semester was the most important solution of the severe economic and financial crisis, which the EU plunged back into in 2009. Its creation took over two years of institutional and political labour, the goal of which was the creation of a mechanism that would prevent future crises. The current political environment in the EU, however, is hostile towards European rules. 

With more and more political territories being taken over by eurosceptics and nationalists, Jean-Claude Juncker’s Commission decided that it is more prudent to step back on the rules, instead of feeding more fuel to the anti-European forces. This year, the EC did not even bother hiding behind Brussels verbal balancing acts. Economics Affairs Commissioner Pierre Moscovici (France, Socialists and Democrats), under the resigned look of EC Vice-President Valdis Dombrovskis (Latvia, EPP), stated very directly that there are “economic, social, and political realities” lying behind this year’s recommendation and budgetary decisions. This is serious progress, compared to last year when the EC simply passed the ball to member states. 

No sanctions for Portugal and Spain

So far, the EC has not levied sanctions on a member state for breaking the fiscal rules. It is not going to do it this year either. Instead, it gave another deferment to Spain and Portugal to correct their budget deficits and fulfil commitments made. The two countries get an extra year to get their finances back in the line of the Stability and Growth Pact. The reason behind this is that there are upcoming elections in Spain, after attempts to form a government after the December 20th vote failed. Spaniards will go back to the ballot boxes on June 26th. Situation is similar in Portugal as well. Commissioner Moscovici explained that the previous Portuguese recommendation expired in December, and the one to Spain was no longer realistic. “This is not the right moment, economically or politically, to take this step [sanctions]”, added the French Commissioner and clarified that there is no government in Spain at the moment which could undertake the necessary reforms. 

The cases of Portugal and Spain will be reviewed again in July, when it is expected that Lisbon and Madrid will have more political stability. And what is the situation in the two countries? The EC analysis shows that Spain is going through macroeconomic imbalances. The word here is specifically about high internal and external debt (public and private) and high unemployment. The Commission is worried that if no adequate steps are taken, Spanish problems could adversely affect the euro area, because of the size of Spanish economy. 

The public debt-to-GDP ratio will slowly drop during the three-year period of the national reforms programme – from 99.2% in 2015 to 96% in 2019. The EC thinks that projections for this year and 2017 are plausible, but further on they look too optimistic. The spring economic forecast provides that Spanish budget deficit this year will be 3.9% of GDP, while the Spanish reforms programme expects 3.6%. EC and Spanish expectations for next year also disagree. Spanish forecasts are for 2.9% and the EC expects 3.1%. Besides, the EC sees risks for the fruition of its highest projections, stemming from the implementation of measures negotiated in March and April. 

In its recommendation to Spain, the EC insists that deficit is lowered to 3.7% of GDP this year and to 2.5% next year. Structural balance should be improved by 0.25% of GDP this year and 0.5% next year. 

Regarding reforms, the EC has several serious issues with Spanish economy. It continues to be low-productive, unemployment is a huge problem, not just because of the size of it, but also because of the quality of the labour force, and there are also problems with public procurement, similar to the Bulgarian problem. Spain has considerably enhanced the quality of legislation regarding public procurement, but there are discrepancies in its implementation in the various administrations. There are also not enough control mechanisms to ensure rules are being followed. Procedures continue to be non-transparent, procurements are often contested, contracts are often changed, there is no clarity in the terms. Another very serious Spanish problem is that it fights unemployment mainly by temporary contracts, which the EC feels is limiting the stimuli for investment in human capital, keeping in mind that almost 60% of long-term unemployed are low-qualified. 

Spain continues to have a problem with low productivity. The EC explains this with the fact that enterprises in Spain are mainly small. Recommendations to the country are focused on the integration of labour market, improving education and training. 

The EC analysis on Portugal is much more detailed than the Spanish one and uncovers deeper issues. Portugal is one of the countries, which went through the disciplinary process of euro area bailout programmes. It was the second country to exit its bailout programme after Ireland and hopes were that it is almost as successful a case as Ireland. It turned out facts are somewhat different. At the moment, Portugal suffers excessive macroeconomic imbalances and this is the big difference with Spain, where these imbalances are not too large yet. Those are the huge external debts, private and public, the high percentage of non-performing loans, and high unemployment. According to the EC, Lisbon is failing to implement a successful policy in important sectors as the goods and services market, restructuring corporate debt, fiscal matters, and the labour market. 

On fiscal matters Portugal, too, is in the corrective part of the Stability and Growth Pact. The country failed to correct its excessive deficit by the year 2015 and failed to follow the Council’s recommendations (respectively the EC ones). For this year the government has set a goal of lowering budget deficit to 2.2% of GDP, which the EC deems too optimistic, so it recommends the target is 2.3%. Portugal is one of the states with excessive public debt. Government expectations are that it will drop this year to 124.8% of GDP and will reach 110.3% in 2020. The EC feels these are far too optimistic projections. In its spring economic forecast, the Commission believes that Portugal’s debt will reach 126% this year and as late as next year it will be 124% of GDP. 

The biggest challenge to Portuguese economy, which is expected to grow by 1.5% this year, is private sector debt. Funding for small and middle-sized enterprises is difficult, which stops investments and growth, thinks the EC. The country is among those which have problems in the judiciary. In the Portuguese case, it is about tax court cases. Public procurement is also a problem, although the EC finds the assignment process more or less transparent. What is wrong is that the possibility for direct awarding is being overused. In the period 2013-2015, this procedure was used in 87.3% of cases. 

In its recommendations, the EC urges Portugal to keep minimum wage consistent with the needs of employment and competitiveness, to undertake measures for dealing with long-term unemployment, to increase transparency in public procurement. The most detailed one in the case of Portugal is the fiscal recommendation, which contradicts Commissioner Moscovici’s statement that fiscal policy is no longer a leading subject in the European semester. EC analyses for the two countries show exactly the opposite, and in the case of Spain there is even a concern voiced that the problems might spillover on other parts of the euro area, which would renew its debt crisis. 

Italy is the big winner in this year’s European semester

Italy has the most interesting case in this year’s edition of the European semester, because Italy is the country, which has deep and true reforms going on over the last year after decades of delays. The EC analysis on Italy is the most thorough and deep of all of the 28 analyses this year. A large portion of it actually is reasoning for the decision to further stretch fiscal rules’ flexibility as a reward for the government of Matteo Renzi, who led a large scale campaign at the European level in order to secure some fiscal breathing space and political backing at the background of difficult political challenges at home. You could really say that if anyone deserves a break it is Matteo Renzi. The fact that others got breaks without having earned them, however, makes EC objectivity questionable. 

Commissioner Moscovici defended his argument by saying that EC recommendations and analyses are based not only on completion of previous commitments, but also on future promises. In the case if Italy this is “a very clear commitment down in black and white”.   

What is the state of the Italian economy? Same as the Portuguese, the Italian economy suffers over excessive macroeconomic imbalances – week productivity growth and high public debt. The Italian scenario, too, hides dangers of spilling over into the entire euro area if measures are not taken. Unlike Portugal and Spain, however, Italy is not in the correcting part of the Stability and Growth Pact, but in the preventive one. It is just that this does not in the least lessen Italy’s problem with excessive debt. It is namely it that needs to be the subject of sanctions, for Italy has kept not managing to lower it to acceptable levels for decades. Last year, the country’s public debt was 132.7% of GDP and this spring the EC revised its expectations upwards – Italian debt is expected to be 132.7% this year. In its winter forecast the EC thought it would be 132.4%. 

The situation is even more serious next year. The EC figures Italian public debt will reach 131.8% of GDP, which is considerably higher than 130.6% expected in the winter forecast. Italian national reforms programme aims at lowering debt to 123.8% of GDP in 2019, which seems ambitious, but plausible to the EC, provided the government’s privatisation intentions come through. According to the EC, Italy has not done enough to abide by the rules about public debt, but Rome’s requests for allowances are viewed as being reasonable. Italy is implementing reforms in several key sectors, which will affect public finances’ sustainability. These are reforms in public administration, goods and services market, the labour market, the judiciary, education, the taxation system, non-performing loans, and insolvency procedures. 

Consequences of these reforms are expected to affect gross domestic product by 2.2%, which the EC finds realistic. If fully implemented, these reforms will generate an effect on public finances. Thus, the EC honours Italy’s request for one more deviation from fiscal rules, amounting to 0.5% of GDP for this year, adding to the already requested deviation of 0.1% last autumn. This is the budget “price” of these reforms now. Additional deviation is granted to Italy because of the financial burden it is suffering because of the refugee crisis, as well as security measures. All of these deviation requests that the EC honours will affect the achieving of the mid-term budget objective. 

What the EC honours for this year is a total deviation of 0.5% of GDP for investments and implementing structural reforms. The decision does not free Italy of making fiscal efforts. The EC thinks this year are needed spending cuts of “at least” 0.6% of GDP. 

Regarding reforms themselves, the EC analysis has nothing in common with previous documents, which kept repeating verbatim the appeals for the same reforms. There is a serious step forward made regarding the public administration reform. There are serious steps taken regarding the fight against corruption as well, some of which the EC insisted on for a long time. Long legal proceedings continue to be an issue, as well as the large number of pending civil and commercial court cases. One of the longest put-off reforms – that of the labour market – is now a fact. It is expected to come to fruition over the next few years. There is not so much success in reforming the services sector – also one of the EC’s most persistent recommendations. Handling non-performing loans is also among this year’s recommendations.

Pierre Moscovici stated that decisions made were far from easy. Whatever is done will always get criticised, he said. Jean-Claude Juncker’s Commission is not the first one to compromise with the rules. José Manuel Barroso’s Commission also made exceptions in 2013. Again regarding Spain. The mass negligence of country-specific recommendations provoked a discussion on reforming the EU’s economic governance, but to no avail. Changes of the rules are back on the agenda. There are no specific proposals as of yet, though. 

This year’s European semester showed something else as well, that there is no unified view in the EC about economic philosophy. Commissioner Moscovici unequivocally announced the end of the austerian era, but not all share his opinion, as is evident from this year’s documents. Until recently, the European semester was given as an example of how unity can pull the Union out of a crisis. The 2010 reform was done with the purpose of preventing new crises. There were hopes that the refugees crisis could have such effect. Instead, the EC denounced its own rules in the name of political peace and quiet. How long will it hold on for and who will take responsibility if the crisis comes back with a bang, once more because of not following the rules? We will not get an answer to this question anytime soon, for all the attention is now focused on June 23rd, when Great Britain’s referendum on its membership in the EU will take place, and its impact on the Union.

Translated by Stanimir Stoev

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