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New EU rules would make unorthodox fiscal practices more difficult

A new legislation to be adopted in June may change the EU’s economy and its image in the eye of investors.

“Branding has never been a strong point of the EU,” pointed out Zoltán Batka, journalist of political daily Népszabadság, when discussing reasons for low coverage of some important EU-related topics with Damis Yannis, head of Unit of Media Services and Monitoring of the European Parliament in Brussels. He was right. If it was, most people in Europe would know by now that a legislation destined to reshape the EU’s economy is about to be approved.

“Economic Governance”, the package hoped to save the euro, may not sound sexy at all, it is still the hottest item on the EU’s agenda right now. Consisting of a set laws called a “six pack”, (a catchy title, at the very least), it would prevent and sanction countries running up too much debt.

Many of its elements are neither new nor special. It calls for self-restraint, aiming to reduce state deficit under 60%, or orders belt-tightening measures for those who have exceeded their capacities. It is not the first time the EU has tried to discipline misbehaving member states, but the results have never been satisfactory. This time, at least in the EU’s expectation, it is going to be different. Member states have agreed to take a tougher stance on those peers that handle their financial affairs improperly and hand over more control the European Commission (EC). With the enhanced authority, the Commission could assess, warn and fine countries that cheat, overspend or create bubbles. Rules, however, will not center solely on fiscal situation, countries’ macroeconomic state will also be watched closely.

To help the EU orientate, a list of indicators will be set up in every country that could be used as a reference to spot imbalances. The indicators (e.g. internal income inequalities, unemployment rate, real estate asset price evolution, net foreign asset positions, etc.) are chosen so that they give a clear picture of a country’s internal and external imbalances. Indicators are important because they can reveal hidden problems. They are not a fixed set – they follow the changes of the market and the economy. “A country may have good macroeconomic indicators, a shrinking budget, a state debt getting closer to 60%. Still, an imbalance procedure can be started against it as the likelihood for a real estate bubble is high,” MEP Ildikó Gálné Pelcz explained the mechanism.

With more enforcement power given to the EC, countries will have less chance to bargain their way out of corrective measures as they have done. (So far, enforcement has been mainly the responsibility of the Council of the European Union, where member states often turned a blind eye to each other’s faults.) This will not happen in the future. If the package is spared from watering down and passes, non-complying eurozone countries could face harsh fines.

But first, they would be given a chance to rectify the problem by following the EC’s recommendations.  If they don’t, they are to pay an interest-bearing deposit of 0.1% of GDP, which could reach 0.3% of GDP if the country says no to taking the corrective measures. If it manages to correct the mistake, the deposit is returned.  If not, it can turn into a fine of as much as 0.5% of GDP.  To show member states they are now really serious, the EC can levy a new one-off fine of 0.5% of GDP for countries caught fudging their accounts. Non-compliance will be made more difficult too, as the country has to make a formal political will to go against the recommendations (defined policy) of the EC:

Revenue from fines and interest from deposits will be channeled into the European Stability Mechanism replacing the current temporary crisis fund from 2013.  Until it is set up, money will be sent to the European Investment Bank, rather than to Member States not running excessive deficits as proposed earlier.

Although these sanctions will only apply to member states with euro, countries outside the eurozone should not feel relieved either. They, just like eurozone countries with debt above 60% of GDP, would need to reduce their excess debt by an average of 5% per year over a three-year period.

Methods used for debt reduction will be assessed too. Since the new economic approach intends to create sustainability, only investments with long-term benefits (for the society) will be counted. That is, the commission can decide whether, for example, building football pitches for a championship or renovating hospitals better serves long-term stability.

The new package is strict, the question is whether it will remain so? Countries which have accumulated huge debts obviously don’t back this strategy and argue it interferes too intensely in their economy. Tensions in the European Parliament are high, especially now that the time for final vote is approaching. Reconciling opposing parties and concluding the agreement by the end of June would be an achievement of the Hungarian presidency.

In great part, it is the merit of Hungarian experts and diplomats that the negotiations between the Council and the EP over the package of six legislative proposals have progressed so well. According to Zsuzsa Beszteri, head of the Permanent Representation of Hungary in Brussels, the work of Hungarian diplomats have been highly appreciated/valued by EU experts.

The overall aim of this package, beyond saving the euro, is to send investors a reassuring message about the European market. It has done sufficient damages to the market that investors did not separate crisis-stricken countries from the rest of the EU. While Europe is ailing, China and the US have advanced. “The world is booming, but the European Union isn’t,” MEP Edit Herczog remarked to the Budapest Business Journal. She added that to get public support, MEPs also need to promote this policy.

It is not sure if the new legislation will be approved in June or not. But the news of the stricter policy has already lifted investor confidence. If the agreement was reached next month, it would give a favorable signal to the markets and would show that Europe is back on track.