Fiscal debate set to dominate European politics – POLITICO

Mujtaba Rahman Head of Eurasia Group’s Europe practice and columnist for Politico Europe. He tweets at @Mij_Europe.

There are three financial debates set to dominate European politics this year.

The first is how the European Union responded to the US Inflationary Reduction Act (IRA).

Here, a reform of the EU’s state aid framework is on the cards, but many member states are pushing for a two-pillar approach that would see the bloc take on new common debt. Otherwise, they argue, relaxing state aid rules would disproportionately benefit German industry, which would, in turn, undermine the core principle of the bloc’s single market – the so-called level playing field.

In this regard, European Commissioner Thierry Breton has proposed a “sovereignty fund”, with commissioners and member states essentially positioning themselves in three camps: one that does not support any relaxation of EU state aid rules – but will go along with it. As long as relaxation is targeted and temporary — or general financing (the Nordics); a second that supports a significant relaxation of the state aid framework but no general debt (Germany); and a third that support both (France).

All this has led to unholy alliances, including an unexpected one between North and South — Italy supporting the Nordics, because it doesn’t believe a more common debt is on the table.

As always, however, Berlin’s position will be crucial in all these cases.

To win over member states worried about Germany’s superior fiscal firepower, German Chancellor Olaf Scholz has had to approve a mid-term review of the EU budget that will begin in earnest in the summer. Otherwise, the Chancellery may struggle to win agreement from other restive member states for a more permanently flexible state aid regime.

Moreover, in the interim, Germany is behind several measures to close the financing gap – for example, the remaining approximately 136 billion euros of existing Recovery and Resilience (RRF) loans that have not been taken out have been refinanced, so they can be used to prevent IRAs. European Investment Bank-backed loans could also be part of the policy mix, easing concerns among member states determined to preserve a level playing field.

But none of this will be easy or smooth, and there is real opposition both inside and outside Germany to a serious mid-term review of the multiyear fiscal framework — and especially to the idea of ​​more modest debt.

The country’s Finance Minister Christian Lindner of the Free Democrats (FDP) is one of the main contenders here. Having already made several concessions to his coalition partners, particularly on domestic fiscal policy, he wants to ensure the government sticks to its deal on any additional general debt — both Lindner’s and the FDP’s credibility as defenders of sound public finances has been damaged by significant increases in government spending. .

Concerns about whether member countries can digest all the money already flowing to them through their RRF allowances, as well as a desire not to fuel inflation, also dominate German concerns.

To win over member states worried about Germany’s superior fiscal firepower, German Chancellor Olaf Scholz has to approve a mid-term review of the EU budget that will begin in earnest in the summer. Pool photo by Louise Joly/AFP via Getty Images

However, once the shooting stops there will be more general debt pressures to rebuild Ukraine. As one senior French official told me: “At some point this year, the EU will have to put forward the most money for post-war reconstruction.”

It is also seen as important leverage in keeping Europe relevant to the Ukraine dialogue, as the EU enjoys much less credibility than the US on key questions of territorial and security guarantees and reforms in Ukraine, which will be key to negotiations. Its EU membership prospects — as last week’s summit in Kiev showed.

Interestingly, there are some tentative signs that the Commission is positioning itself for a larger financial role in post-war reconstruction in Ukraine. A secretariat, working through the G7, has recently been set up, and will be responsible for taking this work forward, with a key role for the Commission.

Additionally, two key personnel moves in Brussels have particularly raised eyebrows, with Commission President Ursula von der Leyen tapping Gert Jan Koopman, a senior Dutch official who manages the Commission’s powerful Directorate-General (DG) budget, to take over DG Nier. Commission that will be responsible for managing the EU’s enlargement to Ukraine. In parallel, Stephanie Riso, von der Leyen’s influential and highly respected deputy head of cabinet, replaced Koopman as head of DG Budget.

The moves are notable because Koopman and Riso were two of the architects behind the EU’s massive €750 billion NextGenerationEU initiative, which helped EU economies recover from the COVID-19 pandemic.

In Brussels, private estimates of Ukraine’s post-war reconstruction costs now range from €300 billion to €1.5 trillion, while Ukraine’s energy infrastructure is seen as a plausible figure of €600-700 billion in light of ongoing Russian targets. Achieving even a fraction of this figure would require more innovative financial engineering than the EU budget, which is why Koopman and Riso’s moves are interesting.

Paris reckons that Scholes will have no choice but to back the idea of ​​more EU borrowing for Ukraine. Even inside Germany, senior officials believe Lindner will have fewer constraints on Ukraine.

Finally, the last major debate concerns the reform of the European Union’s financial rulebook, the Stability and Growth Pact (SGP), which has been suspended since the start of the pandemic. And due to come into effect next year, member states are now debating what the new rules should be given the pandemic, the war in Ukraine and the EU’s experience with the RRF.

Last year, the Commission proposed a major overhaul of the bloc’s fiscal rules, aimed at simplifying them and moving away from broadly standardized debt relief paths to ad hoc tailored, country-specific ones, also factoring in their structural reforms – a first formalization of an approach. Introduced by former Commission President Jean-Claude Juncker.

However, Germany does not believe that the Commission’s changes are more transparent, or that they will materially improve compliance and help member states tolerate the high debt levels they now build up.

To address these concerns, the Commission has begun running “real world” simulations — looking at the practical implications of what its proposed changes would mean for Italy’s adjustment path. This will be important for the following debate.

Germany does not believe the Commission’s changes are more transparent, or that they will materially improve compliance and help member states tolerate the high debt levels they now incur. John Thais/AFP via Getty Images

As always, the Commission’s assessment will be as much a technical exercise as a political one: if Italy’s adjustment path is too demanding, it will lose the support of other reform-minded member states; But if they relax too much, they won’t win Berlin – although officials aren’t sure they can do anything to “win Berlin”.

Finance ministers will debate the reforms at their meeting next Tuesday, and von der Leyen is hopeful he can secure legislative changes this year, although others in Berlin are more pessimistic and believe it could take much longer. Indeed, if finance ministers and EU leaders cannot agree on something this month, EU leaders will likely have to intervene at their meeting in Brussels at the end of March.

The risk then is that SGP reform turns into a policy debate where all member states agree on its urgency but no one can agree on what it should look like, so the debate stalls.

Unable to agree on new rules, the EU could then find itself caught between two equally irrelevant options – suspending EU financial rules again next year, or defaulting on the old ones. And like reform, this will not be an easy political debate to resolve.