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 François 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...

What to expect from the Commission's new economics team

Will France's Moscovici (left) be effectively shackled by
Finland's Katainen (centre) and Latvia's Dombrovskis (right)?

The new European Commission (EC) also sees the overhaul of its approach to the Eurozone. While Pierre Moscovici holds the Economic and Financial Affairs post (essentially Olli Rehn’s successor), he will be overseen by the Vice Presidents (VPs) for Jobs, Growth, Investment and Competitiveness and the Euro and Social Dialogue – Jyrki Katainen and Valdis Dombrovskis respectively.

An edge has been added to all this with quick German criticism of the decision to give former French Finance Minister Moscovici such a prominent economic post.

We have already pointed out in our full response to the new Commission that, contrary to popular belief (at least in some quarters in Germany), this does not necessarily change much – a lot of Eurozone rules are already set in stone. However, it is important to delve a bit more into who has what powers or controls which areas?

Katainen’s key responsibilities:

• Helping bring together an investment package to mobilise €300bn in additional public and private investment via the European Investment Bank within the next three months – expected to be discussed at tomorrow’s eurogroup meeting and unveiled soon.
• Coordinating the mid-term review of Europe 2020 strategy and long-term EU budget.
• Pushing economic policy coordination in line with view of “social market economy” while also pursuing a strong structural reform agenda.

Dombrovskis:

• Steering the ongoing reform of the Economic and Monetary Union and, importantly, in charge of pursuing the work of the four Presidents' report on creating a 'deep and genuine' EMU. This suggests he will play a significant role in the bid to create a sounder eurozone and finding a way to marry the existing currency union with greater political union. It's important to note that this will bring him into regular contact with Lord Hill who is responsible for banking union in the new Commission - exactly how the financial stability aspect and the eurozone prosperity aspect will fit together here will be interesting to watch.
• Formal oversight of the European semester – the mechanism through which budget rules are enforced in the eurozone. Also tasked with reviewing the mechanisms for achieving structural reform.

Moscovici:

• As might be expected there is significant overlap with those above. He has also been tasked with handling the European semester. It is expected he will handle the day to day evaluation and, in cooperation with others, will sign off on national budgets and reform plans.
• The language around the Stability and Growth Pact is also in line with previous thinking, tasking Moscovici with making “best possible use of the flexibility that is built into” the rules.
• The focus of this role seems to be on the macroeconomics and fiscal coordination of the eurozone. With that in mind, its expected Moscovici will attend eurogroup meetings on behalf of the Commission.

Overall then, while France may have got what it wished for, Moscovici looks firmly shackled to two fiscal conservatives. None of his tasks relating to the Eurozone are separated from these two VPs. More broadly, as the FT has pointed out, Moscovici (a French socialist) is also severely ideologically outnumbered not only within the broader Commission but specifically in the economic and financial posts.

Furthermore, the language used in the text of the letters remains quite Germanic and in line with the thinking of the current Commission:

“Combining growth-friendly fiscal consolidation, structural reforms and targeted support to investment will be key to a sustainable and strong recovery.”

“Sustainable growth cannot be built on ever-growing mountains of debt. We also know well that it is mainly companies that create jobs, not governments or EU institutions.”

There are also numerous mentions of “sound public finances” and the “social market economy” both core elements of the prevailing German economic thinking.

What to expect from the new Commission in terms of eurozone economic policy?

Finally, there are a couple of hints of what key proposals may be coming in the future. We have already mentioned the reference to a new investment package and the desire to push ahead with reviewing the current surveillance system. A further development seems to be for all those involved to try to engage a “broader range of actors at national level”, make the measures taken to improve the Eurozone more “socially legitimate” and find a more democratic alternative to the EU/IMF/ECB Troika. This suggests fostering national support for the likely continuation of significant structural reform and fiscal consolidation will be a key task for these Commissioners.

With that in mind, there is one final interesting line which is found in both Moscovici’s and Dombrovskis’ letter, they are tasked with forming:

“Proposals to encourage further structural reforms, possibly supported by financial incentives and a targeted fiscal capacity at Euro zone level”

This sounds eerily like a revival of the reform contracts, which Germany has been pushing for some time. The idea has been gaining ground once again after ECB President Mario Draghi suggested that structural reform should have similar oversight to that currently seen for national budgets. The latter part is also interesting, albeit very cryptic and vague. It could refer to the creation of a eurozone budget, possibly focused on tackling unemployment and related costs. Equally, it could refer to something along the lines of a wider assessment of the eurozone’s fiscal capacity and using it where there is scope to do so – meaning some kind of fiscal expansion in Germany (and other strong states) to offset fiscal contraction elsewhere.

Expect movement on these issues in coming months.

Lord Hill is the EU's new financial services Commissioner - but what is his remit and who does he report to?

With the future of the UK seemingly hanging by a thread it is understandable that events north of the border are dominating attention, but today's announcement of the new European Commission also has far-reaching consequences for the future of the UK's EU membership and the EU itself.

As we set out in our flash analysis, the appointment of Lord Hill to the key financial services portfolio (pending approval by MEPs) is a win for the UK, and the general reformist outlook of the Commission, with other crucial posts (Internal Market and Competition) held by liberal, pro-free trade, non-eurozone countries, provides grounds for cautious optimism.

What will Lord Hill's portfolio include?

• Overseeing the creation of the banking union – a crucial policy for the eurozone but also one which threatens to split the EU into euro-ins and outs. In his new role, Lord Hill can ensure this does not happen. That being said, this is a very tricky role to manage (with numerous competing interests), especially for a non-eurozone country.
• Power to review the role of the European supervisory authorities, institutions which have been controversial in the UK since their creation.
• Responsibility for a 'Capital Markets Union'. While this remains vague it could be a good initiative for the UK since London is already the centre of European capital markets. Lord Hill can base the union around the single market rather than the eurozone.

As the charts below show, the Commission has also been re-organised with a series of policy clusters, with the UK being at the heart of all the major decisions relating to the single market, jobs and growth and the Eurozone. Each 'cluster' will be headed by a Vice-President, previously a largely meaningless role but now with additional agenda setting powers and the ability to stop legislative proposals from other Commissioners.

Lord Hill will 'report' to two Vice Presidents who will "steer and co-ordinate" depending on the issue at hand - the new "Jobs, Growth, Investment and Competitiveness" VP Jyrki Katainen and the "Euro and Social Dialogue" VP Valdis Dombrovskis (both of whom are former PMs). In terms of the two VPs, Dombrovskis is likely to supervise the banking union aspects of Lord Hill's post while Katainen will oversee the more single market aspects, although even here, there is plenty of scope for overlap.

Lord Hill's portfolio also has some overlap (and therefore potential conflict) with France's new Economic and Monetary Affairs Commissioner Pierre Moscovici .The potential for Anglo-French clashes within the Commission is relatively limited since Moscovici will be primarily tasked with macroeconomic eurozone policies rather than financial markets, but one potentially fraught area could the be Financial Transaction Tax or a Common Consolidated Corporate Tax Base. Juncker has asked Moscovici to finalise negotiations over both.

It remains to be seen how the relationship between VPs and different clusters will work in practice, especially as Juncker himself has insisted that "In the new Commission, there are no first or second-class Commissioners", and since decisions in the College of Commissioners have traditionally been taken by a majority of all Commissioners in a secret vote. However, Juncker also made clear that the Vice-Presidents “can stop any initiative, including legislative initiatives” of other commissioners – effectively acting as “a filter”.

Time will tell how potential disputes play out or are resolved and to what extent the VPs can truly veto proposals. What is clear is that the relationship between these four men could be crucially important.

Italy slips again into recession: time for Renzi to re-focus his reform plans?

When Matteo Renzi was widely tipped to take over as Italian Prime Minister back in February, we wrote on this blog: 

Renzi may be able to muster wider parliamentary support than [his predecessor Enrico] Letta, but he would still be stuck with a diverse coalition with smaller centrist and centre-right parties – meaning that the difficulties in pushing ahead any significant political and/or economic reform would not evaporate.

A few months later, it is fair to say the prediction was broadly correct. In his first keynote speech in the Italian parliament, Renzi pledged to implement one big reform per month. However, not much has been achieved so far:

• Some of the promised reforms have been passed only in part (such as the reform of the labour market);
• Others have been proposed by the government but are still awaiting parliamentary approval (such as the reform of the electoral law);
• Others have been announced but have yet to be turned into an official legislative proposal (such as the reform of the judiciary).

To be fair to Renzi, his reform plans involve changes Italy has failed to make for decades. However, there is little doubt the pressure is slowly mounting on the ambitious Italian Prime Minister - especially in light of the latest daunting economic data. Italy has entered recession again. Its GDP contracted by 0.2% in the second quarter of 2014 - worse than expected. The country's national statistics office ISTAT now expects Italian GDP to shrink by 0.3% this year, unless the trend is reversed. This is nowhere near the 0.8% GDP growth initially predicted by Renzi's government. By contrast, Spain is going to upgrade its growth forecast to +1.5% and +2% for 2014 and 2015 respectively.

Needless to say, the meagre growth prospects are raising questions in Brussels, Berlin and Frankfurt over Italy's ability to keep its deficit below the 'magic' EU threshold of 3% of GDP and start reducing its mountain of public debt. Unless Renzi can show substantial progress on the reform side, he's unlikely to achieve any of the 'flexibility' on the application of EU fiscal rules that he's been demanding - along with French President François Hollande - over the past few weeks, and may find himself left with little wiggle room. This would set the scene for another political stand-off between the core and periphery of the eurozone - a scenario which few emerge from looking good.

Perhaps more worryingly, Renzi seems to be currently focusing too much of his reform efforts on the political-institutional side. The reform of the Italian Senate - which has recently taken the centre stage in Rome - is of great symbolic importance and will help speed up the decision-making process once (and if) passed. But its economic impact is limited, and it involves changing the Constitution, meaning that it may not be finalised until early 2015 and will then also be put to a referendum - whose outcome cannot be taken for granted at this stage. Italy can only benefit from the removal of the institutional blockages stemming from a system where the two chambers of parliament have equal powers. However, Italy's economic situation means Renzi should consider investing his best energy and political capital elsewhere - not least because economic reform is the key area where his EU counterparts wish to see progress.

On the economic front, the main achievement of Renzi's government to date is probably a tax cut worth €80 a month for employees earning less than €25,000 a year. The measure may have played a part in Renzi's Democratic Party winning an outstanding 40.8% of votes at the European Parliament elections in May - but the jury is still out as regards its effectiveness as a means to boost domestic demand.

Furthermore, uncertainty remains over Italy's plans to cut public spending and use the savings to finance tax cuts for workers and businesses. Carlo Cottarelli, the Italian government's special commissioner for public spending reform, has recently warned on his blog that the resources he's expected to raise via spending cuts next year are already being used to fund new spending projects. In practice, this means less money to cut the tax burden on Italian businesses and workers - which is among the highest in the world and has been identified as a key pillar of economic reform.

Predictably, Renzi was off to a strong start in terms of trust from both Italian voters and Italy's European partners. However, the time may have come for him to re-focus his priorities and push harder on economic reform. A more efficient parliamentary system and electoral law, while very necessary, will do little to help him win any meaningful concessions in Europe. A thriving economy that grows at an acceptable pace will.

Why Cameron needs to make a swift decision on the UK's next EU Commissioner

In a recent briefing, we stressed that David Cameron needs to pick a 'heavy-hitter' as UK's next European Commissioner if he wants to secure a key portfolio for the UK. Our point is reinforced by a quick look at the candidates being (more or less officially) lined up by other EU member states.

If the UK drags its feet on 'declaring' its candidate, and then sends someone not considered up for the job, we suspect its chances will pretty much have evaporated.

FRANCE - Former Finance Minister Pierre Moscovici is regarded as the frontrunner. The possible alternative could be Élisabeth Guigou, who has served as French Europe Minister, Justice Minister and Employment Minister.

GERMANY - Günther Oettinger looks very likely to stay on as German Commissioner. A former Minister-President of Baden-Württemberg, he has gained influence within Angela Merkel's CDU party during his five years as EU Energy Commissioner.
 
ITALY - Foreign Minister Federica Mogherini is widely tipped to become the new Italian Commissioner. She is currently regarded as the frontrunner to replace Lady Ashton as EU foreign policy chief. 

FINLAND - Former Prime Minister Jyrki Katainen will be the new Finnish Commissioner. He has already replaced Olli Rehn, who had to take up his seat in the European Parliament. Importantly, Katainen stepped down as Finnish Prime Minister precisely because he had set his eyes on a job in Brussels.

SPAIN - Former Agriculture Minister Miguel Arias Cañete is the favourite to become the new Spanish Commissioner. He resigned in April after being picked by Spanish Prime Minister Mariano Rajoy as Partido Popular's top candidate in the European Parliament elections.

POLAND - Various names have been suggested. Foreign Minister Radosław Sikorski remains the frontrunner (despite the recent wiretapping scandal). Former Finance Minister Jacek Rostowski and former EU Budget Commissioner Janusz Lewandowski - recently elected as an MEP - are also in the race.

NETHERLANDS - The frontrunner is Finance Minister and Eurogroup Chairman Jeroen Dijsselbloem, who is one of the two big contenders for the key post of Economic and Monetary Affairs Commissioner along with France's Pierre Moscovici.

ESTONIA - Former Prime Minister Andrus Ansip, leader of the liberal Estonian Reform Party, will be the new Estonian Commissioner, according to what Jean-Claude Juncker just said during his hearing with MEPs from the ALDE group.

What is somewhat different with this lot is that it includes a range of acting or former senior ministers still very much operating on the political centre stage in their respective countries. With some exceptions, the time when countries sent to Brussels whoever the sitting government tried to 'get rid of' seems pretty much over.

Cameron better get a move on.

Juncker: The next Economic and Monetary Affairs Commissioner will be a Socialist

UPDATE (14:15) - One possibility we have not considered in our original blog post is that European Commission portfolios can change. They can be split, broadened, and so forth.

However, at this stage it is quite hard to know whether and how this will happen. Hence, our reasoning is based on the existing portfolios.

ORIGINAL BLOG POST (13:15)  

Pieces are falling into place with regard to the composition of the next European Commission. Jean-Claude Juncker, who is waiting to be confirmed as new Commission President by MEPs in a vote next Tuesday, has just said that the next EU Commissioner for Economic and Monetary Affairs will be a Socialist.

Given the recent debate over EU fiscal rules and their 'flexibility', this sounds like a key pledge from Juncker to secure the backing of centre-left MEPs - since the Economic and Monetary Affairs Commissioner is responsible for enforcing such rules.

Now, two candidates for the post spring to mind instantly: former French Economy Minister Pierre Moscovici and Dutch Finance Minister Jeroen Dijsselbloem, both from their respective countries' centre-left parties. The decision will likely also depend on what happens to the Presidency of the Eurogroup of eurozone finance ministers - with Spain making no secret of its interest in the job.

Scenario 1 - Dijsselbloem becomes the new EU Economic and Monetary Affairs Commissioner

This looks very likely to happen if Spain secures the Presidency of the Eurogroup. German Chancellor Angela Merkel would not be keen to see Mediterranean countries holding the posts of ECB President (Italy), Eurogroup President (Spain), and Economic and Monetary Affairs Commissioner (France) at the same time.

This would also mean that France will push to secure another key economic portfolio for Moscovici: Internal Market, Competition or Trade. This would not be ideal from David Cameron's point of view, although the UK would be likely to get whichever of the bigger briefs France did not get.

Scenario 2 - Moscovici becomes the new EU Economic and Monetary Affairs Commissioner

This would probably mean that Dijsselbloem will stay as Eurogroup President. At that point, Spain could be 'compensated' with an important portfolio in the new Commission. According to the Spanish media, Miguel Arias Cañete - a former centre-right Agriculture Minister who is widely tipped to be appointed Spain's new Commissioner - would be interested in the Trade brief.

Under this scenario, the UK would possibly have a greater chance of securing the Internal Market or the Competition portfolio (both very relevant, as we explained here) - not least because France would no longer be a contender. That said, as we pointed out above, Germany is probably wary of this scenario. And the UK may well be concerned about France controlling the brief which has the most impact on the issue of the balance of power between euro 'ins' and 'outs'.

One to watch for the UK: Finland's Jyrki Katainen  

One more thing to bear in mind. Until today, former Finnish Prime Minister Jyrki Katainen was seen as a strong candidate to succeed his fellow national Olli Rehn as Economic and Monetary Affairs Commissioner. However, it now seems he will have to go for another portfolio. This could have important implications for the UK. Under a positive scenario, reform-minded Finland along with the UK could secure the Internal Market brief as well as the Competition portfolios. Indeed, France getting the Economic and Monetary Affairs portfolio could increase the chances of this happening. 

This is all quite speculative, and based on wishes Juncker expressed during his hearing with the centre-left S&D group in the European Parliament. National governments will play an important role when the time to assign portfolios in the new European Commission comes.

At the moment, there is still a decent chance of the UK securing a good porfolio despite the Juncker débâcle. One thing is clear, though: most other EU countries have already settled on high-profile candidates (note the numerous mentions of both former and acting finance ministers and prime ministers above), while the UK is yet to even decide on a clear shortlist of candidates. It is time to kick it into gear on this front.