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Wednesday, October 29, 2014

France and Italy get preliminary approval of their budgets, but it's not the end of the story

The European Commission has given France and Italy a preliminary nod through on their draft budgets for 2015. In a statement released yesterday evening, Commission Vice-President Jyrki Katainen said:
"After taking into account all of the further information and improvements communicated to us in recent days, I cannot immediately identify cases of 'particularly serious non-compliance' which would oblige us to consider a negative opinion at this stage in the process."
An outright rejection of the French and Italian budget plans was always unlikely, as it was in no-one's interest to trigger an almighty row involving the second and third largest Eurozone economies. However, doing nothing was also never really an option for the Commission. Had it let France and Italy get away with draft budgets that were not only clearly deviating from their deficit reduction commitments but also not even acting to try and meet them, the credibility of EU fiscal rules - already wafer-thin - would have been shattered.

Over the past few days, both France and Italy pledged to make additional cuts to those initially planned for next year. Therefore, at least in terms of political narrative, the Commission got the upper hand in this first round. It stood up for budget consolidation, and it made its demand for extra efforts heard in Paris and Rome. On the other hand, for all their anti-austerity bluster, French President Fran├žois Hollande and Italian Prime Minister Matteo Renzi are likely to come across as eventually bending to the will of Brussels.

That said, this is by no means the end of the story. The measures proposed by France and Italy to achieve the extra deficit reductions look far from structural. Also, as the FT notes, the changes are still short of what the Commission demanded and remain vaguely defined: 
    • In his letter to Katainen, French Finance Minister Michel Sapin mentions the lower interest rates on French debt, the lower contribution to the EU budget recently announced by the Commission (we have written extensively on this issue, see here and here), and a strengthening of the fight against tax evasion.
    • Similarly, his Italian counterpart Pier Carlo Padoan said he would use a €3.3 billion tesoretto (literally 'little treasure', but basically a reserve fund), originally set aside to lower the tax burden in 2015, to reduce deficit instead. However, there seems to be no guarantee that Italy will be able to find the same amount of money every year.
      The Commission will issue its final verdict on the draft 2015 budgets of all Eurozone countries by the end of November. We would expect the Commission to come up with a set of stringent recommendations for France and Italy, although an entirely negative opinion looks unlikely. In the end, we may well see a replay of the current discussion. In the meantime, as the contrasting headlines from the New York Times today show, some may struggle to discern who exactly capitulated... 

      The print version and online version of the New York Times today struggle to judge who blinked first...


      Jesper said...

      The short story seems to be:
      "The noose is slowly tightening".

      Or maybe this is more appropriate:

      Kealan Flynn said...

      France and Italy have already won. What's the Commission going to do when the second and third largest European economies decide what cuts they'll make, which reforms they'll implement, and when or even if they will do them? EU budget rules, while designed for all and intended to apply equally to all, are in practice only for small Member States, who are easy to push around and, notably in the case of Ireland, far too willing to put up with it.

      David Horton said...

      You are right Kealan, although I would argue that EU budget rules are definitely not designed for all. They are designed for the furtherance of Germany and maybe France. However, as you say, they are certainly intended to apply equally to all, large and small. So you have a set of iron rules that are disproportionate because of the very simple reason that larger economies can tweak, swap or if they feel like it, ignore the rules, as they choose. And if a smaller nation such as Ireland ever tried it, there would be serious frowning and protestation.

      I travel to Ireland regularly and well remember the disrespectful and bullying way that Ireland was coerced into voting again for Lisbon. Most of the people I spoke with at that time were angry, but ultimately frustrated at their powerlessness to challenge Germany and the EU. As you say, easy to push around, because of the size of the economy.

      So although the French and Italian budgetary plans are for practical purposes, deficient against what the European Commission was demanding; the sheer size of their economies will result in the EU adopting a compromise position that will let Paris and Rome of the same hook that Ireland, Lisbon or Madrid are hoisted upon. I would expect that any representation made to the Commission about equitability by a smaller Eurozone nation will be acknowledged with a rueful shrug of “Well? What else could we do?”

      EU member states do not have an equal voice and this is likely to to feed anti-EU sentiment across the continent. Critically, although UK can get out of the EU, I fear that for the twenty six smaller the EU nations, it is already too late. You have no alternative but to march forwards into the United States of Europe.

      I wonder whether Griffiths, DeValera or Collins would be happy to see the independence that cost Ireland so much, being meekly handed back over the sea; and for what? A few pieces of silver?

      jon livesey said...

      There is nothing factually inaccurate about this column, but to pose this in terms of who "won" and who "blinked" somewhat misses the point.

      The euro area as a whole remains in pretty deep crisis. The ECB balance sheet has grown, but Bank lending has fallen sharply.

      Investment is down, unemployment is up, youth unemployment and school dropouts are up, millions of jobs have been lost, Spanish Banks are still sitting on billions in non-performing loans.

      Letting France and Italy miss the official goals by a little just isn't enough. Euro area countries need to make enormous investments for the future. If they continue to run the euro area as an exercise in balancing the books, stagnation will be with us for a decade or more.

      Rollo said...

      The pretence is that the EURO crisis is over. But it goes on and on. It is just not the slow motion car crash we thought it was; it is an even slower motion train crash.

      Anonymous said...

      Absolutely right Kealan and David Horton. Both France and Germany broke the Maastrict Treaty when they allowed their deficits to exceed 3% of GDP. Both countries should have been heavily fined by the EC ….but they didn't pay a cent.
      The EU is heading towards a United States of Socialist Europe (USSE) dominated by Germany. Does USSE sound familiar? Given the centenary commerations of WW1 it could be 3rd time luck for Germany. But this time the UK will not rescue Europe from this folly.

      Rik said...

      Makes perfectly clear that rules also the new ones are there to be broken. And fiscal compact and similar nonsense is not worth the paper it is written on.

      Meaning if German etc support would fall for some reason, it is party time again and now for so many countries that the thing will be history.