Communication from the Commission to the Council and the European Parliament -  Public Finances in EMU 2006 - The first year of the revised Stability and Growth Pact {SEC(2006) 751}
Date: 2006-06-13
Institutions: European Commission
Subjects: coordination of EMU policies, development policy, economic growth, economic policy, governance, public finance, stability pact

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 13.6.2006 
COM(2006) 304 final 

COMMUNICATION FROM THE COMMISSION  
TO THE COUNCIL AND THE EUROPEAN PARLIAMENT 

Public Finances in EMU 2006 – The first year of the revised Stability and Growth Pact  

{SEC(2006) 751} 

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COMMUNICATION FROM THE COMMISSION  
TO THE COUNCIL AND THE EUROPEAN PARLIAMENT 

Public Finances in EMU 2006 – The first year of the revised Stability and Growth Pact 

1. 

THE REVISED STABILITY AND GROWTH PACT IS ONE YEAR OLD 

One  year  has  passed  since  the  EU  Heads  of  State  and  Government  endorsed  the  main 
elements for reforming the Stability and Growth Pact (SGP), on the basis of ideas put forward 
by the Commission in a Communication in September 2004. The Commission had suggested 
that  an  enriched  common  fiscal  framework  with  a  strong  economic  rationale  would  allow 
differences in economic situations across the enlarged EU to be better catered for and would 
contribute to greater credibility and ownership of the SGP in the Member States, building on 
the culture of sound fiscal policy established in the EU over the last decade. 

The 2005 SGP reform confirmed the fundamental rules and principles of the Treaty and re-
established the consensus among the 25 Member States for sound fiscal policies. The 3 % and 
60 % ceilings for government deficit and debt remain the anchors of the system. Notably, the 
revised SGP contains a number of provisions contributing towards an early identification and 
a prompt and sustainable correction of excessive deficits.  

At  the  same  time,  the  SGP  reform  increased  the  flexibility  and  economic  rationale  of  the 
framework.  The  revised  SGP  notably  gives  greater  attention  to  debt  developments  and  the 
long-term 
implementation  of  structural  policies 
sustainability of government finances in line with the Lisbon strategy for growth and jobs. It 
requires Member States to strengthen budgetary consolidation efforts in economic good times, 
which  is  essential  to  create  budgetary  margins  for  less  favourable  times.  Medium  term 
objectives are reinforced by a clearer link to sustainability and country-specific situations. In 
the excessive deficit procedure, decisions and recommendations are now taken following an 
overall  economic  analysis,  and  an  increased  focus  is  put  on  structural  fiscal  consolidation 
efforts rather than only on short-term nominal results.  

that  enhance  growth  potential  and 

Overall, the 2005 reform strengthened the SGP and reaffirmed its core role in the budgetary 
co-ordination  process  as  an  instrument  which  contributes  to  achieving  a  high  degree  of 
macroeconomic  stability,  an  essential  condition  for  sustained  economic  and  employment 
growth, as recognised by the Integrated Guidelines.  

The  new  framework  formally  entered  into  force  in  summer  2005,  with  the  adoption  by  the 
Council of a corresponding package of secondary legislation1. Since then, Member States, the 
Commission and the Council have had all to learn how to live with the new rules and ensure 
that they are effectively implemented. One year after the reform, the Commission reviews the 
implementation of the revised SGP and highlights the challenges ahead.  

1 

Council Regulations (EC) No 1055/05 and (EC) No 1056/05 amending Council Regulations (EC) No 
1466/97 and (EC) No 1467/97, were adopted on 7 July 2005. 

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2. 

EXPERIENCE DURING THE FIRST YEAR 

The  first-year  experience  with  the  revised  SGP  is  rather  positive.  Overall,  the  budgetary 
adjustment  has  resumed  and  there  has  been  a  smooth  and  consistent  implementation  of  the 
SGP  procedures,  benefiting  from  an  increased  economic  rationale  for  decisions  and 
recommendations.  Some  concerns,  however,  are  emerging  as  regards  the  implementation  of 
the  preventive  arm  of  the  Pact,  as  it  is  not  clear  yet  whether  fiscal  consolidation  will  be 
stepped  up  in  line  with  the  improving  growth  prospects.  The  measure  of  success  for  the 
revised  Pact  will  be  the  extent  to  which  Member  States  will  achieve  the  necessary  fiscal 
adjustment over the years.  

(i) Positive experience, notably concerning the corrective arm of the SGP 

Improved  economic  rationale  of  decisions  and  recommendations  in  the  excessive  deficit 
procedure 

The revised SGP includes a number of important provisions ensuring that excessive deficits 
are  properly  identified.  It  allows  to  better  take  into  account  country-specific,  economic 
considerations  in  the  application  of  the  excessive  deficit  procedure.  It  foresees  that,  when  a 
deficit  exceeds  3  %  of  GDP,  the  Commission  should  always  prepare  a  report  providing  an 
overall assessment of the economic and budgetary situation in the Member State concerned. 
Since  March  2005,  the  Commission  has  adopted  such reports for three Member States. The 
reports  gave  consideration  to  all  elements  that  appeared  relevant  for  an  evaluation  of  the 
situation when deciding on the existence of an excessive deficit and when setting the deadline 
for its correction.  

The revised SGP remains a rules-based system 

The revised SGP specifies that deficits in excess of 3 % of GDP which are not temporary or 
which do not remain close to the reference value should be considered as excessive. In fact, 
since the reform, all deficits in excess of 3 % of GDP – in some cases by a small margin – 
have been considered excessive. This confirms that the SGP remains essentially a rules-based 
framework, which is the best guarantee for commitments to be enforced and for all Member 
States to be treated equally.  

Realistic deadlines were set for correcting the excessive deficits… 

While requiring the prompt correction of excessive deficits remains the guiding principle for 
the  establishment  of  Council  recommendations,  the  room  for  economic  judgement  in  the 
excessive deficit procedure has been used by the Council to set realistic deadlines for Member 
States  to  correct  their  excessive  deficit.  In  this  perspective,  Member  States  with  weak 
economic  growth  prospects  have  been  given  longer  deadlines  for  the  correction  of  sizable 
excessive deficit (two to three years). Member States with a deficit only slightly above 3 % 
and growth projected at close to or above potential have been given a short deadline.  

Improved cooperation at EU level has allowed setting deadlines taking into account the fiscal 
consolidation strategies envisaged at national level, provided that these strategies were fully 
consistent with the SGP rules.  

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…while significant structural efforts were recommended 

Taking  into  account  economic  conditions  has  not  led,  as  some  feared  at  the  moment  of  the 
reform, to more lenient decisions and recommendations. The fiscal adjustments requested for 
Member States in EDP by the Council under the revised SGP have been significantly larger 
than both those recommended in the past and the benchmark of an annual fiscal effort of at 
least 0.5 % of GDP in structural terms. Moreover, the recommended structural fiscal efforts 
exclude one-off measures or those with only temporary effects on the budget balances. This 
helps  focusing  on  measures  that  contribute  to  sound  public  finances  and  budgetary 
sustainability in the long term and ensures that excessive deficits are corrected in a permanent 
way.  

The  fiscal  targets  of  Member  States  in  EDP  are  broadly  in  line  with  the  requirements 
formulated by the Council in its recommendations, suggesting that the new Pact is better in 
influencing national budgetary policy plans and decisions. Over the next year we will be able 
to  better  assess  whether  this  effectively  translates  into  concrete  actions.  To  foster  effective 
action,  the  Commission  stands  ready  to  take  the  necessary  steps  in  the  event  that  Member 
States do not comply with the Council’s recommendations. 

More attention to debt levels and developments 

In the context of the EDP, debt developments have been devoted more attention. It has been 
assessed whether debt levels above 60 % of GDP have been decreasing at a sufficient speed 
and approaching the reference value at an appropriate pace. There was closer monitoring of 
the  operations  which  had  a  negative  impact  on  debt  levels,  including  developments  in  the 
stock-flow adjustment. 

Better economic dialogue between the Commission, the Council and the Member States 

In  March  2005,  when  agreeing  on  the  revised  SGP,  the  Council  stressed  that  improved 
cooperation between the Commission, the Council and Member States was important in order 
to strengthen national ownership and enforcement of the SGP rules.  

The experience with the revised SGP has shown that, by introducing more room for economic 
judgement  in  the  fiscal  surveillance  process,  the  reform  has  stimulated  a  constructive  and 
transparent  economic  policy  dialogue  at  EU  level  on  the  individual  country  cases.  This  has 
strengthened  peer  support and pressure which, together  with  the increased ownership of  the 
Council  recommendations  by  the  Member  States  involved,  has  contributed  to  a  smooth  and 
efficient  operation  of  the  Pact.  The  convergence  of  views  between  the  Commission  and  the 
Council in the assessment of the 2005 Stability and Convergence Programme Updates and in 
the  recommendations  and  decisions  under  the  excessive  deficit  procedure  since  the  SGP 
reform should be seen in this context.  

(ii) Some concerns related to the implementation of the preventive part of the Pact  

In  light  of  the  past  experience  of  recurrent  failures  in  attaining  the  medium-term  budgetary 
targets,  the  2005  SGP  reform  introduced  a  number  of  changes  strengthening  the  preventive 
arm of the Pact by increasing its rationale.  

One criticism addressed to the original Stability and Growth Pact was that a uniform medium 
term objective of close to balance or in surplus imposed in some countries experiencing high 

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nominal growth an undue policy stance. The revised SGP no longer requires a Member State 
to  aim  for  a  uniform  close-to-balance  budgetary  position  in  the  medium  term.  Rather, 
differentiated  medium-term  objectives  are  set  for  each  Member  State,  taking  into  account 
country-specific  economic  and  budgetary  circumstances, so  as  to  provide  a  sufficient  safety 
margin with respect to the 3 % of GDP reference value, and to ensure the achievement and the 
maintenance  of  prudent  debt  levels  over  time.  The  revised  SGP  also  includes  a  number  of 
sound and simple fiscal policy principles for Member States that have not yet achieved their 
medium-term target and for fiscal behaviour in the cyclical upswings. In particular, Member 
States  of  the  euro  area  or  participating  in  ERM-II  should  pursue  an  annual  structural 
adjustment of 0.5 % of GDP as a benchmark. A higher adjustment should be pursued in good 
times. 

Country-specific  medium-term  budgetary  objectives  reflect  economic  fundamentals  and 
national strategies… 

In the 2005 round of updated Stability and Convergence Programmes, different medium-term 
budgetary objectives were set for individual Member States. Countries with a relatively high 
risk  to  fiscal  sustainability  (high  debt,  low  potential  growth)  have  medium-term  budgetary 
objectives  of  balance  or  a  small  surplus.  Member  States  with  low  debt  and  high  potential 
growth  prospects  aim  for  a  deficit  of  up  to  1  %  of  GDP,  allowing  room  for  budgetary 
manoeuvre, while stabilising the debt at prudent values.  

Interestingly,  some  countries  have  proposed  medium-term  targets  that  are  more  ambitious 
than  strictly  required  by  the  revised  SGP.  In  most  cases,  this  was  to  allow  consistency 
between  the  objectives  set  in  the  European  context  and  a  national  strategy  to  ensure  the 
sustainability  of  government  finances.  This  provides  evidence  that  objectives  that  better 
reflect country-specific economic realities in an enlarged EU of 25 Member States are better 
accepted as anchors for fiscal policy-making at national level. 

…but planned fiscal efforts to achieve the objectives are not always sufficiently ambitious and 
fall short of the 0.5 % benchmark in 2006 

The  2005  updates  of  Stability  and  Convergence  Programmes  confirmed  the  intentions  of 
those  Member  States  that  have  not  yet  achieved  their  medium-term  budgetary  objective  to 
make progress towards it. However, given the large gap, in some cases, between current fiscal 
positions and the recently agreed country-specific medium-term budgetary objectives, larger 
planned consolidation efforts could have been expected.  

The  budgetary  plans  of  Member  States  which  have  not  yet  reached  the  medium-term 
objective  (but  not  in  EDP)  for  the  years  2007  and  2008  are  in  line  with  the  benchmark 
structural adjustment of 0.5 % of GDP of the new SGP. However, the planned adjustment for 
2006 falls far short of the 0.5 % adjustment. According to the Commission Spring Forecast, 
on average the structural balance for the EU will not improve and  for some Member States 
will  even  deteriorate,  turning  the  fiscal  stance  expansionary  and  pro-cyclical.  Rigorous 
budgetary  execution  and,  if  necessary,  additional  consolidation  measures  in  2006,  together 
with  ambitious  fiscal  policy  plans  for  2007  are  needed  in  order  to  reduce  the  gap  between 
actual efforts and requirements under the SGP. 

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Despite  clear  improvements,  some  questions  remain  on  the  credibility  of  the  medium-term 
budgetary adjustments planned by Member States 

The experience under the original SGP showed that, to be credible, medium-term budgetary 
plans need to be based on realistic and cautious macroeconomic forecasts and underpinned by 
permanent measures and structural reforms. On this point as well, the assessment is mixed.  

An encouraging feature of the last round of Stability and Convergence Programmes is that the 
medium-term budgetary projections are, in almost all cases, based on realistic macroeconomic 
assumptions.  This  constitutes  a  major  improvement  compared  to  the  experience  of  the 
previous  years  when  budgetary  forecasts  were  typically  based  on  overly  optimistic 
macroeconomic  forecasts.  Another  positive  development  is  that  the  recourse  to  one-off  and 
other  temporary  measures  within  a  medium-term  planning  has  vanished.  Such  measures 
represent less than 0.1 % of the EU GDP in 2006 and are negligible in 2007 and 2008. In a 
number  of  cases,  however,  the  measures  underlying  the  envisaged  consolidation  are  not 
sufficiently  specified.  The  combination,  in  some  programmes,  of  a  back-loaded  fiscal 
adjustment with a lack of specification of measures underlying the projected consolidation is 
a source of concern.  

3. 

CHALLENGES AHEAD  

Overall, the one-year experience with the revised SGP shows that the EU fiscal framework is 
re-gaining credibility. The SGP reform has permitted an enhanced economic rationale of the 
rules, increased ownership of the framework by Member States, and a smoother and more co-
operative  process  in  its  application.  These  developments  warrant  some  optimism  on  future 
implementation. However, looking ahead, a number of challenges are already identified.  

(i) Ensuring that the spirit of the reform is followed during good times 

Budgetary  results  in  2005  are  encouraging.  The  nominal  deficit  in  the  EU  was  reduced  to 
2.3 % of GDP, down from 2.6 % of GDP in 2004. The structural balance improved by about 
¾ % of GDP, the largest improvement since 1997. The larger-than-expected deficit reduction 
came mainly as a result of larger-than-expected revenues which, in line with the revised rules, 
were allocated to deficit reduction, but also due to strengthened policy implementation.  

Economic indicators and forecasts confirm that the cyclical conditions continue to improve in 
the  EU.  Experience  has  highlighted  the  importance  of  conducting  prudent  fiscal  policies  in 
good times to contain the accumulation of debt and assure its reduction to sustainable levels. 
Analysis  has  shown  that  pro-cyclical  fiscal  policies  were  quite  frequent  in  the  EU  in  past 
decades, and this year’s Public Finances in EMU report shows that pro-cyclical fiscal policies 
took place especially in good times. Avoiding a pro-cyclical stance in good times in the euro 
area  is  crucial  to  make  rapid  progress  towards  more  sustainable  budgetary  positions  and 
would  also  help  maintain  a  mix  of  monetary  and  fiscal  policies  that  supports  growth  and 
employment.  The  budgetary  plans  formulated  by  Member  States  for  2006  and  the 
Commission’s recent economic forecasts suggest that the current recovery is so far not being 
used to accelerate fiscal consolidation and place public debt on a firmly declining path. Larger 
fiscal  adjustments  should  be  made  in  2006.  The  Commission  will  play  its  role  to  foster  the 
stronger  peer  support  and  pressure  needed  to  ensure  a  more  rigorous  implementation  of  the 
2006 budgets and the drafting of ambitious 2007 budgets.  

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(ii) Increased focus on the sustainability of government finances 

Despite the progress made in reducing the general government deficit, the debt ratio increased 
from 62.4 % of GDP in 2004 to 63.4 % of GDP in 2005 in the EU. In the coming years, a 
combination of stronger economic growth and a stable primary surplus is expected to reverse 
the  upward  trend  in  the  debt  ratio  observed  since  2003.  The  debt  ratio  would  drop  to 
marginally below 63 % of GDP in 2007. In light of the long-term budgetary challenges faced 
by most EU Member States, large reductions in the debt ratios need to be made in the near 
future.  

In a context of population ageing, the  sustainability of government finances must  become a 
core  policy  objective  for  all  EU  Member  States.  The  revised  SGP  rightly  puts  greater 
emphasis on debt and sustainability issues. Since the reform considerable progress has been 
made in understanding the dynamics behind the budgetary impact of ageing. Specifically, the 
Commission and the Member States have agreed on the quantification of the implications for 
government finances of population ageing2.  

Looking ahead, further progress is needed to better integrate long-term and short-term fiscal 
policy  challenges.  By  the  end  of  2006,  the  Commission  will  report  on  the  possibilities  to 
directly  take  into  account  sustainability  considerations  in  the  determination  of  country-
specific  medium-term  budgetary  objectives.  A  number  of  preliminary  considerations  are 
made in the report 'Public Finances in EMU - 2006', with the aim of fostering discussion on 
alternative approaches. 

(iii) Improved statistical governance  

When agreeing on the SGP reform, the Council considered that the effective implementation 
of the fiscal framework relies crucially on the quality, reliability and timeliness of harmonised 
fiscal  statistics  in  accordance  with  European  accounting  standards.  The  Council  considered 
that  the  ongoing  work  to  make  the  European  statistical  system  more  robust  and  less 
vulnerable to misreporting should be strengthened.  

Over  the  last  few  months,  several  developments  have  improved  the  situation.  The  Council 
amended the regulation governing the transmission of fiscal data by Member States in order 
to increase Eurostat’s operational capacity to assess the quality of government statistics and to 
improve  transparency in  the data compilation and notification procedure3.  On  25  May  2005 
the Commission recommended that Member States recognise the European Statistics Code of 
Practice as a common set of standards for statistical authorities in the EU, and the institutional 
set-up  of  national  and  Community  statistical  authorities  has  been  accordingly  been 
strengthened4. 

Building  on  these  efforts,  further  progress  should  be  made  to  ensure  adequate  practices, 
resources and capabilities to produce high-quality statistics at the national and European level.  

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Long-term  budgetary  projections  were  updated  on  the  basis  of  commonly  agreed  assumptions  and 
methods  for  a  wide  range  of  budgetary  items  (pensions,  health-care,  long-term  care,  education  and 
unemployment benefits). 
Council Regulation (EC) No 2103/2005 (OJ L 337, 22.12.2005) amending Council Regulation (EC) No 
3605/93 (OJ L 332, 31.12.1993). 
Communication  from  the  Commission  to  the  European  Parliament  and  to  the  Council  and 
Recommendation  on  the  independence,  integrity  and  accountability  of  the  national  and  Community 
statistical authorities - COM(2005) 217. 

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(iv) Better synergies between fiscal policy and growth  

The best contribution of fiscal policy to growth comes from its role in delivering a sound and 
stable macroeconomic environment, as also indicated in the Integrated Guidelines for growth 
and  jobs.  Nevertheless,  further  synergies  can  and  should  be  explored.  A  challenge  is  for 
example  how  to  foster  the  implementation  of  reforms  that  at  the  same  time  allow  progress 
towards sustainable fiscal positions and enhance growth prospects. The possibility introduced 
by  the  SGP  reform  to  take  into  account  major  structural  reforms  in  the  definition  of  the 
adjustment  path  towards  the  medium-term  objective  should  be  seen  in  this  perspective.  To 
this end, there is a need to improve the understanding and quantification of the economic and 
budgetary  effects  of  structural  reforms.  Moreover,  in  making  progress  towards  sustainable 
fiscal positions, it is important to increasingly focus budgets on growth-enhancing priorities, 
and ensure the best use of the opportunities created by a reducing debt burden. Medium-term-
oriented fiscal rules can provide an important contribution in this respect and those existing 
already in many Member States may be an useful example for others. 

With a view to fostering stable and sustainable growth rates in the EU countries, and notably 
in those Member States still in the process of nominal convergence, increased attention should 
also  be  paid  to  the  implications  of  fiscal  policy  on  macroeconomic  developments.  The 
assessment of fiscal policy in the context of the preventive arm of the SGP should take greater 
account of the overall macroeconomic situation of the country concerned. Particular attention 
could be given to developments in external imbalances, inflation and competitiveness.  

(v) Supporting fiscal rules and institutions at national level 

The  agreement  on  the  SGP  reform  stressed  that  national  fiscal  rules  and  institutions  could 
play  a  more  prominent  role  in  domestic  budgetary  surveillance.  Experience  in  a  number  of 
EU countries has shown that well-designed fiscal rules and institutions support the attainment 
of sustainable budgetary positions and contribute to the avoidance of pro-cyclical policies in 
good times. The Commission welcomed the declaration of Finance Ministers, in the context 
of the SGP reform, on the importance of developing adequate fiscal rules and institutions at 
national level.  

With a view to stimulating the debate on the influence of institutional settings on budgetary 
outcomes,  the  report  'Public  Finances  in  EMU  -  2006'  includes  analytical  studies  providing 
evidence that Member States relying on numerical fiscal rules tend to have lower deficits and 
less  pro-cyclical  fiscal  policies.  At  the  same  time,  it  suggests  that  the  presence  of  national 
institutions in charge of providing independent analysis and recommendations in the area of 
fiscal policy and formulating autonomous credible economic forecasts has a positive impact 
on  budgetary  outcomes.  The  report  studies  country-specific  experiences  and  identifies 
desirable  characteristics  of  fiscal  rules  and  institutions.  Further  work  should  be  pursued  to 
favour the spread of good practices. 

Progress  could  also  be  made  in  strengthening  the  interaction  between  national  budgetary 
procedures  and  the  EU  framework.  This  would  enable  discussions  at  EU  level  to  be  better 
taken  into  account  in  the  preparation  of  national  budgets.  More  intense  discussions  at  EU 
level before draft budgets for the following year are prepared in the Member States would be 
positive for the Member States’ ownership of EU policy coordination. This would also enable 
national  parliaments  to  be  more  involved  in  the  EU  fiscal  surveillance  and  coordination 
process. 

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