EU Ministers Agree on Tough Debt Reduction Rules

As part of an agreement to gradually overhaul the budget framework of the EU, EU finance ministers have given in to German demands for strict debt-reduction regulations.

After months of haggling the package grants EU member states more independence in negotiating debt and deficit plans, but only if they adhere to strict spending limits set by fiscal hawks.

The new framework, while allowing for some wiggle room in the transition period to help states with high debt, also included more strict spending limits that were essential to win over Germany. Germany was initially sceptical of the reforms.

To become law, the political agreement, reached after marathon negotiations among capitals, still needs to be approved by the European Parliament.

Sigrid Kaga, Dutch Finance Minister, stated that the agreement would lead to “ambitious debt reduction in Europe”. This agreement contains fiscal rules which encourage reforms and allow for investment, while being tailored to the particular situation of each member state.

The EU Stability and Growth Pact rules were suspended when the Covid-19 pandemic began, but will be enforced again next year. This will increase pressure on the ministers to reach an agreement.

After costly lockdowns, and an energy crises sparked by Russia’s full-scale invasion in Ukraine, EU countries struggle to reduce spending and are burdened with high levels of debt.

The Eurozone debt is still high, despite its decline, at 90 percent of GDP. In six countries, the debt ratio is over 100 percent.

The ministers decided that the old rules were too strict and rarely enforced and out of touch with the high debt reality. They needed to reform.

The original proposal from the European Commission that sought to give countries greater independence in determining debt reduction plans was the basis for the compromise reached between EU member states.

The framework will require the commission to develop national spending plans for four years, ensuring that debt levels are reduced. The countries can extend this period up to seven years if they commit to reforms that will boost growth.

Two benchmarks for fiscal policy, included in EU Treaties, will remain the same: 60 percent debt to GDP and a 3% annual deficit limit. The ministers decided to drop a requirement to reduce excess debt by 5% per year.

The ministers agreed to implement a spending cap for each year to improve the enforcement of fiscal plans. This will be used as a benchmark to measure a country’s compliance.

Two “safeguards”, added by a group led by Germany who criticized the Commission’s proposals for being too lax, will flank these plans.

Countries with debt ratios exceeding 90 percent of GDP must reduce their excess debt one percentage point annually over the course of their national budget plan. This target is reduced by half for countries with debt levels above 60% but below 90% of GDP.

Those with debt ratios of more than 60% and deficits exceeding 3 percent will have additional targets. They must aim to reduce their deficits by 1.5 percent of GDP, with an annual cut in spending.

Under the agreement, sanctions are strengthened. Countries that fail to meet their spending targets will be subjected to a procedure called excessive deficit, where they would have a 0.5 percent reduction in spending per year.

The Commission has already stated that many of the draft budget plans for 2020 do not meet the thresholds required and will be sanctioned following EU elections.

France won a concession at the last minute that will allow countries to defer interest on debt in the period of 2025-2027. This will reduce the spending restrictions required.

The French Finance Minister Bruno Le Maire stated on X that the pact for stability and growth recognises investment as a priority.

According to those briefed about the discussions, Giancarlo Giorgetti had threatened to veto proposals, but he ultimately said to his colleagues that he would compromise “in the spirit” of compromise.

Some experts have said that the reform does not achieve its original goal of simplifying the rules and ensuring more consistent enforcement.

Lucio Pench is a non-resident fellow at the think tank Bruegel. He was the original author of the commission proposal and now a nonresident fellow.

Negotiations with the European Parliament, which has a more liberal position on rules, will be based on the political agreement that ministers reached.