Encouraging structural reforms and investment: flexibility of the Stability and Growth Pact rules

Archived content
The content on this page is provided for reference purposes only. This content has not been altered or updated since 15/09/2016

Overview

To support the EU's efforts to increase investment levels and encourage structural reforms, the European Council agreed in June 2014 there was a need to explore how the existing rules of the Stability and Growth Pact (SGP) could be applied more flexibly without changing them. 

Following the European Council's guidance, the European Commission issued a communication on 'Making the best use of the flexibility within the existing rules of the SGP' in January 2015.

The communication explains how the Commission intends to apply the Stability and Growth Pact more flexibly when evaluating member states' compliance with the Pact's rules.

The Commission is already applying its new interpretation of the Pact's rules, as there is no need to change the existing rules and, therefore, no need for legislative action.

The Council endorsed a commonly agreed position on the communication in February 2016, which will be used as the basis for an update of the 'Code of Conduct' - a current interpretation of how the SGP rules should be applied ('Specifications for the implementation of the Stability and Growth Pact') .

Key goals

More flexible application of the Stability and Growth Pact rules should help to:

  • encourage implementation of structural reforms 
  • boost investment

In the Council

February 2016: the Council endorsed a commonly agreed position on flexible application of the Stability and Growth Pact. The agreed position will serve as a basis for an update of the Code of Conduct on the implementation of the Stability and Growth Pact.

December 2015: the Council confirmed a commonly agreed position on flexibility within the existing rules of the Stability and Growth Pact. The position was agreed by the Economic and Financial Committee.

October 2015: the Economic and Financial Affairs Council discussed the Commission's communication on the flexibility within the existing rules of the Stability and Growth Pact, based on the presentation by the chairperson of the Economic and Financial Committee. 

January 2015: the Council discussed the flexible application of the SGP rules, focusing on the application of the 'structural reform clause' and the 'investment clause'. The Council also agreed that the Economic and Financial Committee would continue its technical analysis of the Commission communication.

Guidance on the use of flexibility within the stability and growth pact: key points

The communication on the use of flexibility within the stability and growth pact focuses on a more flexible application of the SGP rules by taking account of the following factors:

  1. structural reforms undertaken by member states
  2. investment activities carried out by governments
  3. cyclical conditions in each member state

1. Flexible application of the 'structural reforms clause'

The structural reform clause will be applied differently to member states that are under the preventive arm of the SGP than to those who are under the corrective arm of the SGP.

Member states under the preventive arm of the SGP

Existing rules:

member states that are under SGP's preventive arm are allowed to deviate temporarily from the medium-term budgetary objective(MTO) or from the fiscal adjustment path towards it, if they are implementing major structural reforms. This rule gives member states the possibility of covering the short-term costs of implementing reforms which bring long-term benefits, and grants them more time to reach their MTO.

Flexible application:

The deviation can be granted if structural reforms meet a set of criteria, i.e. if they are:

  • 'major'
  • bring verifiable long-term positive budgetary effects
  • fully implemented

In addition, the clause would be applied for those member states that have not yet started implementing their reforms, but are already able to provide detailed plans with well-specified measures and credible deadlines for their implementation.

The granted temporary deviation cannot exceed 0.5% of GDP, and the member state must reach its medium-term budgetary objective within four years.

Furthermore, member states to which the deviation has been granted must maintain a safety margin to ensure that the deviation does not lead to a situation where the country's government deficit becomes higher than 3% of GDP.

The Council will grant the temporary deviation after the Commission completes the assessment and confirms that the agreed reforms are fully implemented.

Member states under the corrective arm of the stability and growth pact

Existing rules:

the Commission has to examine relevant medium-term economic, budgetary and other factors in a member state before it can initiate an excessive deficit procedure or propose an extension to deadlines for the correction of excessive deficits. These factors cover the implementation of structural reforms. 

Flexible application:

To take into consideration not only ongoing major structural reforms, but also plans for major structural reforms. Such plans must contain clear measures and realistic timelines for their implementation.

This means that if a country under the corrective arm of the SGP has viable reform plans, the Commission may:

  • recommend that the Council grant an extension of the deadline for the correction of the excessive deficit for those countries that are already under the excessive deficit procedure
  • recommend that the Council grant a longer deadline for the correction of the excessive deficit when launching an excessive deficit procedure

Monitoring

The implementation of the reforms will be monitored within the framework of the European Semester. A country that is subject to the excessive imbalance procedure will have to outline its structural reforms in the corrective action plan. In that case, the implementation of reforms will be monitored under the excessive imbalance procedure.

2. Flexible application of the 'investment clause'

Investments related to the European fund for strategic investments (EFSI)

Proposed flexible application:

1. Not to launch the excessive deficit procedure for those member states whose government deficit breaches the 3% of GDP reference value, if the breach is due to an investment in a project that that is co-financed by the EFSI. However, the deviation from the target deficit has to be small and temporary. 

2. Not to take account of small breaches of the debt reference value - 60% of GDP - if the government is participating in EFSI-related investments.

These rules would apply to all member states, irrespective whether they are under the preventive or corrective arm of the SGP.

Other investments 

Existing rules

the SGP allows temporary deviations from the medium-term budgetary objective or from the fiscal adjustment path towards it for those member states whose investments can be considered to be equivalent to major structural reforms. 

Flexible application

The 'investment clause' will be applied to public investments by taking into account the specific situation of each member state.

This means that member states whose investments can be considered to be equivalent to major structural reforms will be granted a temporary deviation from their MTO or the adjustment path towards it, if: 

  • their GDP growth is negative or if their GDP is below its potential
  • the deviation from the MTO or path towards it does not lead to a government deficit greater than 3% of GDP and an appropriate safety margin is preserved to prevent such a breach
  • investment levels are increased as a result of the deviation granted
  • the deviation is linked to the fact that a member state co-finances projects that are also funded by the EU programmes and by the EFSI
  • the member state compensates for temporary deviations within the timeframe established in the member state's programme (stability programme for the euro area member states and convergence programme for non-euro area member states)

These rules would be applicable to member states that are under the preventive arm of the SGP.

The European Commission will review the application of the structural reform and investment clauses by the end of June 2018. The review will examine, among other things, whether the investment clause helped boost new investments and what are the implication of continuing of the investment clause. 

3. Cyclical conditions

Under the preventive arm of the Pact, a more responsive approach to the economic cycle of a member state has been introduced.  The Commission will use a more complex method (a 'matrix') to set each country's fiscal adjustment path, depending on whether the country is experiencing economic difficulties or an economic upturn.  

When assessing the situation in a country that is subject to the excessive deficit procedure (the corrective arm of the Pact), the Commission will distinguish, as far as possible, budgetary developments that are under government's control from those linked to an unexpected decline in economic activity. 

The European Commission is expected to submit a review report to the Council on the effectiveness of the matrix before 30 June 2018. Specifically, it will examine whether the matrix was successful in promoting counter-cyclical policies by the member states and contributed to the achievement of  their medium-term objectives. It will also look into whether the matrix ensured a reduction in government debt at a 'satisfactory pace'.

What is the Stability and Growth Pact?

The Stability and Growth Pact, which provides for both prevention and deterrence, consists of a resolution and two Council regulations:

  • on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies
  • on speeding up and clarifying the implementation of the excessive deficit procedure

What is a medium-term budgetary objective?

The medium-term budgetary objective (MTO) refers to each member state's target structural budget balance relative to GDP, which each country is expected to attain within a certain period of time. The medium-term budgetary objective requires the member states' budgetary positions to be close to balance or in surplus. It also helps to ensure that member states comply with the requirement to maintain their public debt below 60% of GDP and their government deficit below 3% of GDP, and that their public finances overall are sustainable.

The MTO is set for each country individually every three years. It can be reviewed more frequently if a member state is implementing structural reforms that have an impact on its public finances.

The progress that member states should make every year towards this objective is called the 'adjustment path towards the MTO' and is set individually for each country. Progress is monitored through the relevant European Semester reporting procedures.