The corrective arm of the Stability and Growth Pact (SGP) is concerned with the procedure to be followed if a country's public finances fall outside the requirements of the Treaty. It is based on Article 126 of the Treaty which specifies that Member States shall avoid excessive government deficits. It defines the criteria according to which compliance with budgetary discipline should be examined in terms of whether the general government deficit exceeds 3% of GDP or the debt-to-GDP ratio exceeds 60% and is not sufficiently diminishing towards this reference ratio. Hence, an Excessive Deficit Procedure (EDP) can be launched not only on the basis of the deficit criterion but also on the basis of the debt criterion. The corrective arm is implemented through Council Regulation (EC) No 1467/97 of 7 July 1997 on speeding up and clarifying the implementation of the EDP.
The debt reduction benchmark
Following the amendments to the corrective arm that entered into force on 13 December 2011, Member States with debt in excess of 60% of GDP should reduce their debt in line with a numerical benchmark.
In particular, according to Article 2 (1a) of Regulation 1467/97, a government debt ratio above 60% of GDP should be considered in compliance with the debt criterion if its excess over 60% "has decreased over the previous three years at an average rate of one twentieth per year as a benchmark, based on changes over the last three years for which the data is available. The requirement under the debt criterion should also be considered fulfilled if the budgetary forecasts of the Commission indicates that the required reduction in the differential will occur over the
three years period encompassing the two years following the final year for which the data is available."
The compliance with the debt criterion will then be checked in three steps and an excessive deficit procedure could be launched when:
First step: the government debt ratio is above the reference value of 60% of GDP
and
Second step:
bt > bbt = 60% + 0.95/3 (bt-1- 60%) + 0.952/3
(bt-2 - 60%) + 0.953/3 (bt-3 - 60%)
where
bt stands for the debt-to-GDP ratio in year t; bbt stands for the backward-looking benchmark debt ratio in year t;
and
Third step:
(a) bt+2 > bbt+2 = 60% + 0.95/3 (bt+1- 60%)
+ 0.952/3 (bt- 60%) + 0.953/3 (bt-1 - 60%)
where
bbt+2 stands for the forward-looking
benchmark debt ratio;
bt+1and bt+2stand for the debt forecast in year
t+1 and t+2 as estimated by the Commission under the 'no-policy-change' assumption on the basis of the fiscal outcome of year t;and, in parallel
(b) the breach of the benchmark cannot be
attributed to the influence of the cycle.
The proposed formula for the benchmark debt level and the long time horizon over which it is computed is meant to avoid the pitfalls of a simple
benchmark requiring a 1/20th annual reduction of
specifically the volatility of the benchmark and its
vulnerability to manipulation (51).
Graph II.2.2 illustrates the procedure for judging whether a country's debt trajectory is in compliance with the debt benchmark.
Member States subject to excessive deficit procedures opened before the adoption of the debt reduction benchmark have to comply with recommendations and notices focussing on the only requirement to bring their deficit below 3% of GDP in a durable manner.
However, a deficit of 3% of GDP does not, however, ensure that debt-to-GDP ratios diminish sufficiently toward 60% of GDP. In fact, this was the reason why a debt-reduction benchmark had to be introduced. Compliance with the existing recommendation to correct the excessive deficit does not thus ensure that the debt benchmark will be also complied with in the year following the correction. On the contrary, lacking a sizeable additional correction, a breach would be likely. In order to avoid having to launch an excessive deficit procedure on the basis of the debt criterion at the same time of the abrogation of the procedure based on the deficit criterion, a three-year transitional period has been envisaged. In particular, as specified by the same Article 2 (1a)
of Regulation 1467/97, "For a Member State that
is subject to an excessive deficit procedure on 8 November 2011 and for a period of three years from the correction of the excessive deficit, the requirement under the debt criterion shall be considered fulfilled if the Member State concerned makes sufficient progress towards compliance as assessed in the opinion adopted by the Council on its stability or convergence programme."
Extension of the list of the other relevant factors
Before establishing that an excessive deficit exists, the Commission prepares a report under Article 126(3) TFEU if a Member State does not fulfil the requirements specified under either the deficit or debt criteria. The Commission report should take into account the other relevant factors whose list
(51) The properties of the formula were presented in last year edition of the Report (European Commission, 2011).
has been enlarged by the amendments to regulation
1467/97 (52).
However, as regards relevant factors, the deficit criterion and the debt criterion are not on an equal footing. Before establishing that an excessive deficit exists on the basis of the debt criterion, the whole range of relevant factors covered by the Commission report should be taken into account, which is not always the case for the launch of excessive deficit procedures based on the deficit criterion.
(52) According to Article 2(3) of regulation 1467/97, "The report shall reflect, as appropriate:
(a) the developments in the medium-term economic position, in particular potential growth, including the various contributions provided by labour, capital accumulation and total factor productivity, cyclical developments, and the private sector net savings position;
(b) the developments in the medium-term budgetary positions, including, in particular, the record of adjustment towards the medium-term budgetary objective, the level of the primary balance and developments in primary expenditure, both current and capital, the implementation of policies in the context of the prevention and correction of excessive macroeconomic imbalances, the implementation of policies in the context of the common growth strategy of the Union, and the overall quality of public finances, in particular the effectiveness of national budgetary frameworks;
(c) the developments in the medium-term government debt position, its dynamics and sustainability, including, in particular, risk factors including the maturity structure and currency denomination of the debt, stock-flow adjustment and its composition, accumulated reserves and other financial assets, guarantees, in particular those linked to the financial sector, and any implicit liabilities related to ageing and private debt, to the extent that it may represent a contingent implicit liability for the government. The Commission shall give due and express consideration to
any other factors which, in the opinion of the Member State concerned, are relevant in order to comprehensively assess compliance with deficit and debt criteria and which the Member State has put forward to the Council and the Commission. In that context, particular consideration shall be given to financial contributions to fostering international solidarity and achieving the policy goals of the Union, the debt incurred in the form of bilateral and multilateral support between Member States in the context of safeguarding financial stability, and the debt related to financial stabilisation operations during major financial disturbances."
In particular, with regard to the deficit criterion, the 2011 reform introduced a distinction between Member States with the debt-to-GDP ratio above or below 60% of GDP. The whole range of other relevant factors has to the taken into account when evaluating the existence of an excessive deficit on the basis of the deficit criterion in Member States with debt-to-GDP ratios below 60% of GDP. Moreover, where the excess of the deficit over 3% of GDP reflects the implementation of a pension reform introducing a multi-pillar system that includes a mandatory fully funded pillar, the Commission and the Council will also consider the net cost of the reform to the publicly managed pillar when assessing developments in EDP deficit figures for Member States, as long as the general government deficit does not significantly exceed a level that can be considered close to 3% of GDP
and the a debt-to-GDP ratio remains below 60% of GDP, on condition that overall fiscal sustainability
is maintained (53).
However, if the Member State's debt ratio exceeds 60% of GDP, when evaluating compliance with the deficit criterion, the relevant factors assessed in the Commission report will be taken into account in the steps leading to the decision on the existence of an excessive deficit only if the general government deficit remains close to the reference value and its excess over the reference value is temporary (this is the so-called "double condition of the overarching principle").
(53) The net cost of the pension reform is measured as its direct impact on the general government deficit (as defined in Article 1 of Regulation 479/2009).
Graph II.2.2: Steps preceding the preparation of a Report under Article 126(3) assessing a possible breach of the debt criterion
Enforcement provisions
Beyond improvement of the corrective arm of the SGP, a new Regulation on the enforcement of budgetary surveillance in the euro area also entered into force on 13 December 2011. This Regulation sets progressive financial sanctions which kick in at an earlier stage of the EDP than was previously the case. A non-interest bearing deposit of 0.2% of GDP may be requested from a euro area country already when it is placed in EDP (either on the basis of its government deficit or debt). Failure of a euro area country to comply with recommendations for corrective action will result in a fine.
Assessment of effective action: which implications?
The 2005 reform of the SGP introduced rules to take into account the fact that, in spite of an
adequate response to the recommendations, the deadline for correction might not be achieved because of unexpected unfavourable economic developments. In case an unexpected economic
event occurs with major unfavourable
consequences for the Member State concerned by the excessive deficit procedure, the possibility extending the deadline for correction without stepping up the procedure is, however, considered only if the Member State has taken "effective action" to comply with the recommendation or notice addressed to it by the Council.
The 2011 reform of the SGP did not change dramatically the provisions on assessment of effective action, but provided some important elements of clarity. First, the recommendations issued after the entry into force of the amendments will include annual nominal targets, which should be consistent with a minimum annual fiscal effort
Box II.2.1: The transition period