Why is the Commission issuing this Communication now?
Member States are required to submit their annual Stability and Convergence Programmes by the end of April. These programmes should include Member States' medium-term fiscal trajectories. We are currently in an exceptional situation and therefore we want to offer Member States some early guidance to assist them in preparing these programmes.
In March 2020, the Commission and Council activated the so-called ‘general escape clause' of the Stability and Growth Pact. While the clause does not suspend the procedures of the Pact, it allows Member States to temporarily depart from the normal budgetary requirements, provided that this does not endanger fiscal sustainability in the medium term. There are currently no numerical fiscal adjustment requirements stemming from the Pact that can guide Member States' fiscal policies. Given that the general escape clause has now been activated for almost one year, it is an appropriate juncture for the Commission to set out the considerations for how a future decision on the deactivation of the clause or its continued activation for 2022 should be taken.
The Recovery and Resilience Facility Regulation entered into force in February 2021, meaning that Member States can now present their recovery and resilience plans to the Commission for assessment. The Communication provides some general indications on Member States' fiscal policy for the period ahead and its link with the funds of NextGenerationEU, in particular the Recovery and Resilience Facility.
What are the main issues covered by the Communication?
The Communication provides some guiding principles for the proper design and quality of fiscal measures, looking at their effectiveness, their gradual adjustment from emergency to targeted measures, and their eventual phasing out.
It sets out the Commission's considerations regarding the deactivation or continued activation of the general escape clause.
The Communication also provides general indications on Member States' medium-term fiscal policy stance. These include a number of topics, such as: the implications for fiscal policy of grant funding from the Recovery and Resilience Facility; and the need for a proper differentiation of fiscal policies in function of Member States' available fiscal space. This guidance will facilitate the coordination of fiscal policies and the preparation of Member States' Stability and Convergence Programmes. The guidance will be further detailed in the Commission's European Semester spring package.
The Communication also confirms the Commission's intention to relaunch the public debate on the economic governance framework once the recovery takes hold.
Does this Communication provide formal fiscal guidance to Member States? How does this differ from the annual European Semester package?
The Communication does not constitute formal guidance to Member States under the European Semester or the Stability and Growth Pact. It seeks to provide more clarity to Member States as they prepare their Stability and Convergence Programmes.
The guidance contained in the Communication today will provide an input to the upcoming ECOFIN and Eurogroup discussions. Based on those discussions, the Commission will propose fiscal policy guidance to Member States as part of the European Semester package in late May 2021.
What fiscal measures have Member States taken to address the coronavirus crisis so far?
Member States have provided an unprecedentedly large amount of fiscal support to their economies during the coronavirus crisis. In 2020, taking automatic adjustments in tax payments and social benefits (so-called ‘automatic stabilisers') together with additional fiscal measures, support is estimated to have been around 8% of GDP in the EU, considerably more than the support provided during the 2008-2009 crisis.
The bulk of new measures in 2020 consisted of additional spending (estimated at 3.3% of GDP). This included emergency spending on health care (around 0.6% of GDP), for example to increase the capacity of health systems, provide protective equipment, and set up testing and tracing systems. Expenditure measures in other areas (2.7% of GDP) consisted of compensations to specific sectors for income losses, as well as short-time work schemes and other items. Tax relief measures are estimated to have accounted for an additional 0.4% of GDP.
Member States also provided sizeable liquidity support in 2020 (around 19% of GDP), mostly in the form of public guarantees. Around a quarter of available guarantees has been taken up so far.
The Commission estimates that these measures cushioned the contraction in GDP by around 4.5 percentage points in 2020.
What are the main features of the EU's fiscal response to the coronavirus pandemic crisis so far?
As the health situation in the EU worsened, the Commission and the Council activated the general escape clause of the Stability and Growth Pact in March 2020. The activation of this clause allowed Member States to temporarily depart from the normal budgetary requirements of the Pact. This facilitated Member States taking steps to sustain the economy during the pandemic and support a sustainable recovery, while safeguarding fiscal sustainability.
Unprecedented EU actions have supported and complemented national fiscal policy responses. The SURE instrument is providing loans on favourable terms to Member States to help them support workers. In 2020, the Council approved a total of €90.3 billion in SURE support for 18 Member States, and the Commission last week proposed to grant €230 million in support to a nineteenth Member State. The European Investment Bank has set up a safety net for businesses, while the European Stability Mechanism's Pandemic Crisis Support Instrument provides a safety net to Member States to support financing of healthcare, as well as cure- and prevention-related costs arising from the coronavirus pandemic. The ECB took a broad set of monetary policy measures, most notably launching the pandemic emergency purchase programme (PEPP) and providing additional liquidity through targeted longer-term refinancing operations. These measures contribute to preserve favourable financing conditions over the pandemic period for all sectors of the economy, thereby underpinning economic activity and safeguarding medium-term price stability.
NextGenerationEU, including the Recovery and Resilience Facility, will ensure a sustainable, even, inclusive and fair recovery. Cohesion policy funds were also redirected to the regions and sectors that most needed them through the Coronavirus Response Investment Initiative Plus.
The EU's policy response also included the use of the full flexibility foreseen under EU State aid rules, in particular by means of a Temporary Framework adopted in March 2020. Since the start of the outbreak, the Commission has taken almost 460 decisions approving nearly 560 national measures notified by 27 Member States and the UK in the context of the coronavirus outbreak. To-date it was amended five times, including to increase the scope of public support for research, the testing and production of products relevant to fight the pandemic, and to protect jobs and further support the economy. It was further extended to enable recapitalisation and subordinated debt measures, to further support small companies and to incentivise private investments. More recently, the Temporary Framework was prolonged until end 2021, certain aid ceilings were increased and the conversion of certain repayable instruments into direct grants was allowed.
What factors will be considered when deciding to deactivate or continue the activation of the general escape clause of the Stability and Growth Pact?
The Commission proposed the activation of the general escape clause in March 2020 as part of its strategy to respond quickly, forcefully and in a coordinated manner to the coronavirus pandemic. It allowed Member States to undertake measures to deal adequately with the crisis, while temporarily departing from the budgetary requirements that would normally apply under the European fiscal framework.
The Communication sets out the Commission's considerations for how a future decision on the deactivation of the clause or its continued activation for 2022 should be taken. In the view of the Commission, the decision should be taken following an overall assessment of the state of the economy based on quantitative criteria. The level of economic activity in the EU or euro area compared to pre-crisis levels (end-2019) would be the key quantitative criterion for the Commission in making its overall assessment of the deactivation or continued application of the general escape clause. Therefore, current preliminary indications would suggest to continue applying the general escape clause in 2022 and to de-activate it as of 2023.
As part of the European Semester spring package in May, and following a dialogue between the Council and the Commission, the Commission will assess the deactivation or continued activation of the general escape clause on the basis of the 2021 Spring Forecast.
Country-specific situations will continue to be taken into account after the deactivation of the general escape clause. In case a Member State has not recovered to the pre-crisis level of economic activity, all the flexibilities within the Stability and Growth Pact will be fully used, in particular when proposing fiscal policy guidance.
How will the EU fiscal rules interact with the Recovery and Resilience Facility?
The Recovery and Resilience Facility (RRF) will support Member States' efforts to increase economic growth through structural reforms and investments, in particular by contributing to the necessary green and digital transitions. The facility will provide €312.5 billion of grants and up to €360 billion of loans to Member States, with these funds oriented towards the economies worst affected by the economic fallout of the pandemic. The facility will help mitigate the risk of divergences in both economic and social conditions within the euro area and the EU.
The roll-out of the Recovery and Resilience Facility will have important implications for national fiscal policies. Expenditure financed by grants from the RRF will provide a substantial boost to the economy in the coming years, without increasing national deficits or debt. It will also allow and encourage Member States to improve the growth-friendliness of their fiscal policies.
It is important that Member States make use of the window of opportunity provided by the RRF, in particular when designing their medium-term fiscal strategies. If RRF support does not result in an increase in investment, it will only temporarily reduce deficits and debt ratios, with no positive effect on potential growth in the medium to long term and risks resulting in a worse composition of public spending. The additional fiscal space provided by the RRF will be temporary and should not be used to finance new recurrent expenditures. Thus, the RRF should support additional productive and high quality investment which will contribute to the recovery and lift potential growth, in particular when combined with structural reforms in line with the country-specific recommendations.
How should Member States design their medium term fiscal strategies?
The Communication sets out some key considerations for Member States for the design of their medium-term fiscal strategies. For 2021, the Council recommended Member States that fiscal policies remain supportive. It is imperative that fiscal policy should remain agile and adjust to the evolving situation. Member States should avoid a premature withdrawal of fiscal support to their economies. Risks of an early withdrawal are higher than the risks associated with keeping support measures in place for too long. Fiscal policies should also take into account the strength of the recovery and fiscal sustainability considerations in the medium term. Fiscal policies should also make best use of the Recovery and Resilience Facility. Once health risks diminish, fiscal measures should gradually pivot to more targeted measures that promote a resilient and sustainable recovery. In the perspective of economic activity gradually normalising in the second half of 2021, Member States' fiscal policies should become more differentiated in 2022.
What type of fiscal measures should Member States take?
Member States should avoid a premature withdrawal of fiscal support to their economies, while adjusting fiscal policy measures to the evolving situation. Once health risks diminish, fiscal support measures should pivot from emergency relief to measures that promote a resilient and sustainable recovery. It is crucial that measures remain well-targeted and efficient, and that their withdrawal is gradual. The quality of fiscal measures will be very important to efficiently support the economy.
Fiscal support measures should avoid creating a permanent burden on public finances. They should remain temporary and targeted, in order to maximise support to the recovery without pre-empting medium-term fiscal strategies. When Member States introduce permanent measures, they should properly fund them to ensure budgetary neutrality in the medium term.
As the economy and individual sectors move into the recovery phase, authorities should step-up active labour market policies in line with the Recommendation on Effective Active Support for Employment (EASE). Targeted support measures should help viable but vulnerable firms to reopen and adjust their business models. Fiscal policy should also prioritise higher public and private investment, while supporting the necessary transitions towards a green and digital economy.
Should fiscal policies be differentiated across Member States?
Member States' fiscal policies should take into account the state of the recovery, fiscal sustainability risks and the need to reduce economic, social and territorial divergences. Increased differentiation in fiscal guidance to Member States should go hand-in-hand with an overall supportive fiscal stance in 2022, avoiding a premature withdrawal of fiscal support.
Debt sustainability risks have increased due to the severe impact of the crisis on public finances, with debt-to-GDP ratios increasing in all Member States. Low interest rates have and continue to provide benign financing conditions for Member States, facilitating the public expenditure that is necessary to boost growth and avoid a low-growth high-debt trap. Credible medium-term fiscal strategies are nevertheless needed to anchor expectations. On balance, Member States with high debt levels should pursue prudent fiscal policies, while preserving nationally-financed investment and using grants from the Recovery and Resilience Facility to fund additional high-quality investment projects. Member States with low sustainability risks should gear their budgets towards supporting the economy further in 2022, taking into account the impact of the RRF. This will contribute to a sustainable recovery in the EU. The overall fiscal impulse, stemming from national budgets and the RRF, needs to remain supportive in 2021 and 2022.
Furthermore, all Member States should focus on improving the composition and quality of their public finances. They should prioritise the fiscal structural reforms that will help provide financing for public policy priorities and contribute to the long-term sustainability of public finances.
What is the status of the review of the economic governance framework?
When the recovery takes hold, the Commission intends to relaunch the public debate on the economic governance framework.
The Commission's review of February 2020 identified well-recognised challenges with the fiscal framework and its implementation. While overall deficit and debt levels decreased, very high public debt had persisted in some Member States prior to the current crisis. The fiscal stance at Member-State level had frequently been pro-cyclical, both in good and in bad times. The composition of public finances had also not become more growth- and investment-friendly. In the event of large economic shocks, the ability to steer the fiscal stance for the euro area had been hampered by a lack of prudent policies in good times and remained constrained as long as it relied exclusively on coordination of national fiscal policies, in the absence of a central fiscal stabilisation capacity. The framework has also grown increasingly complex.
The pandemic has significantly changed the context of the public debate, with higher debt and deficit levels, significant output losses, increased investment needs and the introduction of new policy tools at EU level. Moreover, the general escape clause was activated for the first time. Therefore, the crisis has highlighted the relevance and importance of many of the challenges that the Commission sought to discuss and address in the public debate. Relaunching the public consultation on the economic governance framework will allow the Commission to reflect on these challenges and draw lessons. However, in light of the crisis and the need to focus on the Recovery and Resilience Facility and the immediate policy response, its relaunch has been put on hold.
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