(Bloomberg) -- The European Union is in a political bind as it looks into the unprecedented step of slapping sanctions against Spain and Portugal for breaching budget-deficit limits.
The European Commission is seeking the go-ahead from finance ministers to propose fines and a suspension of some EU regional-development funding after concluding that Spain and Portugal took inadequate steps to narrow deficits. Should the finance ministers support the request as soon as next week, the commission would have 20 days to propose a set of penalties. Any fines could be as high as 0.2 percent of the countries' gross domestic product, while the possible freezing of regional funds could be up to 0.5 percent of their GDP.
The EU has three broad options, which involve different strategic considerations.
DAMNED IF YOU DO
With popular skepticism about the EU's supranational powers on the rise in Europe and the European economy still struggling to emerge from the debt crisis, imposing penalties on euro-area countries risks being economically counterproductive and provoking greater public disaffection with Brussels.
While voter unhappiness in Europe has been highlighted most strongly outside the euro area by last month's U.K. decision to leave the 28-nation EU, populist pressure exists throughout the 19-member euro area.
Sanctions could fuel support for anti-establishment forces that have even less respect for the EU's fiscal straitjacket than do the current governments in Madrid and Lisbon.
DAMNED IF YOU DON'T
After five euro-area countries including Spain and Portugal required emergency international aid, and following the beefing up of the European rulebook that limits fiscal deficits to 3 percent of GDP, the EU would risk losing its credibility as a fiscal inspector by failing to trigger sanctions against Madrid and Lisbon.
This could revive the appearance of laxness that emerged more than a decade ago when Germany intervened politically to fend off a budget warning from Brussels, giving euro-area capitals as a whole an impression that ultimately anything goes under the EU's fiscal framework known as the Stability and Growth Pact.
“To bolster the credibility of the framework and better ensure fiscal discipline, the European Commission will need to step up its enforcement procedures against countries that violate Stability and Growth Pact rules,” the International Monetary Fund said Friday in a report on the euro area.
The risk of letting Spain and Portugal off the hook may be heightened by a power struggle between the EU and another southern member state -- Italy -- over banks. The Italian government is pushing the commission for leeway under EU rules that curb state aid to recapitalize Banca Monte dei Paschi di Siena SpA and other lenders without imposing losses on creditors.
THE EU FUDGE
In all their complexity and obscurity, the EU's economic-governance rules leave regulators and politicians plenty of room for compromise. That's no exception when it comes to the final stage of sanctioning countries over their budgets following years of warnings.
While the fine is by default 0.2 percent of GDP, the commission can invoke “exceptional economic circumstances” or use a “reasoned request” by the targeted country to propose that the penalty be lowered or even canceled.
For the freezing of EU regional funding, the commission has discrepancy to propose the level as long as it's within the overall limit. The ceiling is 0.5 percent of GDP or as much as half of the pledges for the following year, whichever is lower.
“There is a strong tension between the credibility of EU fiscal rules and the uncertainty surrounding the euro zone's economic recovery, which has been exacerbated by Brexit,” Antonio Barroso, a political analyst at Teneo Intelligence in London, said by phone. “Any heavy-handed decision would probably generate a backlash domestically and make it more difficult politically for these countries to meet deficit targets in the future.”
--With assistance from John Martens and Zoe Schneeweiss To contact the reporters on this story: Jonathan Stearns in Brussels at jstearns2@bloomberg.net, Fabio Benedetti-Valentini in Paris at fabiobv@bloomberg.net. To contact the editors responsible for this story: Alan Crawford at acrawford6@bloomberg.net, Andrew J. Barden, Flavia Krause-Jackson
Essential Business Intelligence, Sharp Market Insights, Practical Personal Finance Advice, Daily Fuel, Gold and Silver Prices and Latest Stories — On NDTV Profit.
