Stability and Growth Pact

Stage three of Economic and Monetary Union (EMU) began in 1999. One of its main characteristics is the co-existence of a single monetary policy and fiscal policies which are the responsibility of participating Member States. Against this background, the preparation of a set of rules ensuring budgetary discipline is essential to avoid price and interest rate pressures, which would have negative spillover effects on all euro area countries.

In view of these purposes, the Treaty on European Union includes a set of articles which provide the basis for the budgetary surveillance framework of the European Union (EU). Thus, Article 101 of the Treaty prohibits the ECB or national central banks from providing overdraft facilities or any other type of credit facility as well as from purchasing government debt in the primary market. Article 102 prohibits privileged access to financial institutions by general government entities. Article 103 exempts the EU and the Member-States from being liable for or assuming the commitments of the general government of any Member-State (‘no-bail-out clause’). Finally, Article 104 makes a direct reference to the different phases of the excessive deficit procedure by: 

• Defining excessive deficit and mentioning reference values for the deficit- and debt-to GDP ratios  (paragraph 2);
• Describing the procedures to decide whether an excessive deficit exists in a given Member-State (paragraphs  3 to 6);  
• Characterising the steps to correct the excessive deficit and the measures applicable in case of non-compliance (paragraphs 7 to 11); 
• Establishing the procedure to abrogate its decision on the existence of an excessive deficit (paragraph 12);
• Indicating the voting process, as well as the requirement that the Council shall vote on a recommendation from the Commission (paragraph 13);
• Mentioning the protocol on the excessive deficit procedure annexed to the Treaty (paragraph 14), which sets out the reference values of 3 per cent for the deficit-to-GDP ratio and 60 per cent for the debt-to-GDP ratio.

In addition, Council Regulation No 3605/93 of 22 November 1993 defines deficit as the net borrowing of the general government sector, as laid down in the European System of Accounts, and debt as total gross debt of the general government sector at nominal value outstanding at the end of the year.

The Stability and Growth Pact (SGP) was approved in 1997 and consisted of three legal texts (1). It aimed to strengthen surveillance of budgetary positions and coordinate economic policies under its ‘preventive arm’, as well as clarify the effective implementation of the excessive deficit procedure under its ‘corrective arm’. These objectives translated into the commitment to respect a budgetary position close to balance or in surplus in the medium-term, the obligation to submit and assess Stability and Convergence Programmes to be updated by Member-States on an annual basis, as well as the definition of exceptional circumstances, deadlines to be met and sanctions to be imposed under the excessive deficit procedure.

In the early years of the SGP, the budgetary position of several Member-States deteriorated, followed by ample recourse to temporary measures and considerable statistical revisions. In parallel, the non-approval by the Ecofin Council, in November 2003, of the Commission recommendations on the budgetary situation in Germany and France highlighted a deadlock in the decision-making process.  These developments justified the need for a reform of the SGP, which was implemented in March 2005 with the approval by the European Council of the document “Improvements in the implementation of the Stability and Growth Pact”, introducing a set of changes in the SGP’s regulations (2).

Under the ‘preventive arm’, the main changes introduced with the SGP’s reform consisted in clarifying the definition of the medium-term budgetary objective – MTO and the catching-up process undertaken to reach it. The medium-term budgetary objective is defined in terms of the cyclically adjusted balance, net of temporary measures, as a percentage of GDP. Its value takes into account the debt ratio and potential output growth, and thus can be differentiated among Member-States. Implicit liabilities shall also be relevant to determine the above mentioned objective, once the criteria and modalities are established by the European Council. The medium-term budgetary objective shall preserve a safety margin to the deficit ceiling of 3% of GDP, while ensuring the convergence of the debt ratio to prudent levels. Countries which have yet to attain the medium-term budgetary objective shall approach the value established through a more marked adjustment during periods of favourable economic growth and a more limited adjustment during periods of lower growth. As a reference, the cyclically adjusted balance of these countries, net of temporary measures, is expected to increase by 0.5 percentage points of GDP per year. The implementation of structural reforms, in particular the introduction of funded schemes in social security systems, may justify temporary deviations from the medium-term objective or the adjustment path to reach it.

With regard to the ‘corrective arm’, a new definition of ‘exceptional circumstances’ and ‘other relevant factors’ was introduced in the assessment of possible excessive deficit situations, and the deadlines to be met in the different phases of the excessive deficit procedure were subject to changes. Under ‘exceptional circumstances’, a deficit above the reference value shall not be considered excessive if it is the result of a negative annual growth rate of real GDP or a cumulative output loss due to a protracted period of annual real GDP growth below potential. ‘Other relevant factors’ now include several aspects related to medium- term economic and fiscal prospects and may only be claimed if the excess over the reference value is temporary and of a small magnitude. As a rule, countries continue to be able to correct excessive deficits within one year following identification. However, the existence of special circumstances may warrant an extension of the deadline for the correction by another year. In this case, recommendations may be renewed under the same paragraph of Article 104 of the Treaty.

Following the changes made to the Regulations, a new version of the Code of Conduct was also approved, specifying certain aspects of the performance of the SGP’s ‘preventive arm’ and of the excessive deficit procedure, and providing guidelines regarding the format and content of Stability and Convergence Programmes.