War Brings EU Closer to Suspending Fiscal Rule Again for 2023

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European Union officials are opening the door to suspending their regime limiting debt and deficits for a fourth year as the Russian invasion of Ukraine prompts more spending and clouds the economic outlook. 

A decision on whether to hold off reactivating the so-called Stability and Growth Pact in 2023 can be expected in May, European Commissioner for Economy Paolo Gentiloni said in Brussels on Wednesday as he presented new fiscal guidance. 

“There is for now too much uncertainty,” he told reporters. “We will need to reassess the expected deactivation of the General Escape Clause in 2023 on the basis of our spring forecast, which I will present in mid-May.”

That could mean countries including Italy, whose borrowings have swelled during the pandemic, can continue with deficits beyond a normal limit of 3% of output without facing the threat of punishment by way of fines. 

Gentiloni's remarks provide the first concrete evidence at EU level of how the conflict raging just beyond its borders is starting to affect its fiscal stance as governments rush to shore up defense spending. That's despite the ambitions of some countries that public finances should now begin a period of repair. 

The prospect of a subsiding pandemic had set the scene for a reappraisal of the Pact, with Italy and France arguing that a regime embodied in an EU treaty should be watered down to reflect economic orthodoxy that states growth-friendly policies are the best way to reduce debt. So-called frugals such as the Netherlands contest that approach.

The fiscal guidance unveiled by Gentiloni also pointed to the trade-off he and his officials are seeking as they respond to the needs of individual countries without applying strict rules. 

Member states that can afford to should prioritize investment, “in particular for the green, digital and resilient transition,” the Commission's document said, and “emphasis should be put on a high quality of investment.”

Meanwhile heavily indebted countries -- a group encompassing Italy, Greece, Portugal, Spain and France -- should continue to look at how to cut their borrowings. 

“A gradual fiscal adjustment in high-debt member states is necessary to stabilize and then reduce debt ratios,” the Commission wrote. Nationally-financed spending “should grow more slowly than medium-term potential output,” it said.

Gentiloni said that high energy prices are “central” to the outlook. 

“Prices are now assumed to remain at elevated levels for the whole of 2022,” he said. This “will likely weigh significantly on the expected economic expansion in the EU but without derailing it.”

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