For nearly 10 years, up until last June, France had been in violation of the European Union’s rule, established by the Stability and Growth Pact (SGP) in 1998, that deficits must not exceed 3 percent of GDP. Under the threat of sanctions, France followed the recommendations to reduce its deficit below the limit. Now President Emmanuel Macron’s announcement of fiscal measures to placate the “yellow vest” (gilets jaunes) movement will bring the French deficit back above the limit. In theory, this could land France back in an Excessive Debt Procedure (EDP)—the corrective arm of the SGP, a process requiring the government to submit a plan to correct its deficit—which is also being threatened against the new populist government in Italy.
Yet France could avoid an EDP in 2019. That is because the SGP allows for exceptional and temporary deviation from the deficit rule. More important, France, having been in an EDP recently, is not subject to the very stringent debt rule facing Italy.
To assuage French protesters, Macron cancelled planned increases in the taxes on oil and gasoline and on low-income pensions. He also called for an exemption from taxes and social contributions of overtime and end-of-year bonuses, and an increase in the “employment subsidy” for minimum wage earners. These measures will push the fiscal deficit for 2019 from a forecast 2.8 percent to almost 3.5 percent of GDP. The European Commission must now prepare a report under Article 126(3) of the 20-year-old Treaty on the Functioning of the European Union to assess the case for launching an EDP against France.
First, it must evaluate whether the excessive deficit is “exceptional and temporary”—that is, if it results from an unusual event outside the government’s control or from a severe economic downturn, and whether it will fall below 3 percent following such an occurrence.
The excessive deficit is temporary, but, in our view, certainly not “outside of the Member State’s control.” We will see whether the European institutions share our view. Nevertheless, France’s record of undertaking structural and labor market reforms in 2018 could invite leniency under EU guidelines over whether to open an EDP.
Also in theory, an EDP is warranted because France’s debt is above the threshold of 60 percent of GDP and not decreasing at a sufficient pace. In fact, the European Commission has recommended the opening of such a debt-based EDP against Italy. Could the same reasoning apply to France?
The short answer is no: France and Italy are not subject to the same set of rules. To understand why, one needs to go back to 2011, when the so-called Six-Pack reforms of the SGP operationalized the debt reduction rule and required that those with a debt-to-GDP ratio above 60 percent would have to close the gap to this threshold by 1/20th each year. Several countries, including France, were already in an EDP in 2011 and were required to follow a fiscal adjustment path that had already been defined using considerations other than the new debt reduction rule of the Six-Pack. To provide enough time for these different fiscal consolidation paths to converge, a transition period of three years was thus introduced after the correction of these countries’ excessive deficits. During that period, only “sufficient progress towards compliance” rather than actual compliance with the 1/20th formula is required.
The definition of “sufficient progress” is convoluted but boils down to following a path calculated by the European Commission, the Minimum Linear Structural Adjustment (MLSA), such that the debt rule is satisfied at the end of the transition period. Even before Macron’s fiscal announcements in December, France was unlikely to comply with “the required improvement of 0.8 percent of GDP [in 2019] under the MLSA,” given that the Commission estimated the French fiscal consolidation effort at only 0.2 percent, implying a 0.6 percent gap with the requirement (Staff Working Document on the French Draft Budgetary Plan).
It goes without saying that this gap will now grow much bigger. But only an observed breach of the MLSA can lead to the opening of a debt-based EDP. Thus, a debt-based EDP based on noncompliance with the MLSA can only be opened in 2020 when the breach for 2019 will be observed. But here again, the structural reforms implemented in 2018 could also help France avoid a debt-based EDP.
1. The Six-Pack reforms refer to six regulations and directives reforming the SGP. These included bringing fiscal surveillance into the European Semester, the introduction of the Macroeconomics Imbalance Procedure and the expenditure benchmark, the operationalization of the debt rule, and the introduction of graduated sanctions.