Tuesday, 27 May 2008

UK to face European Commission sanctions for Government deficit?

The Commission is set to send a strong political message to the UK Government on its deficit: according to the Commission’s spring economic forecast, the UK is not setting a good example of budgetary discipline. Joaquin Almunia already announced on 11 June that the Commission will put forward a proposal to open an excessive deficit procedure against the UK for breaching the 3 per cent rule on deficits.

On 28 April, the European Commission presented its spring economic forecast 2008-2009 which is marked by high inflation and low growth. The EU’s growth is expected to come down from 2.8 per cent to 2 per cent this year and to 1.8 per cent in 2009 whereas the autumn forecast had foreseen growth of 2.4 per cent. The slowdown in the eurozone is even more marked as growth in the eurozone is foreseen to fall from 1.7 per cent in 2008 and 1.5 in 2009 from 2.6 per cent in 2007. The Commission had previously foreseen rates of 2.2 per cent this year and 2.1 per cent in 2009 in the eurozone. The turmoil in the financial markets, the United States market slowdown and soaring prices of oil and raw materials are the reasons given by the Commission for “the moderation in growth.” Employment growth is predicted to slow down to 0.8 per cent this year and 0.5 per cent next year in the EU (0.9 per cent and 0.5 per cent, respectively, in the euro area). The unemployment rate is estimated at 6.8 per cent in the EU this year and 7.2 per cent in the euro area.

Even with slow growth, the Commission believes that “the EU economy is holding up relatively well thanks to sound fundamentals and is expected to create 3 million new jobs in 2008-2009.” Consumer price inflation is expected to surge temporarily in 2008 to 3.6 per cent in the EU and 3.2 in the eurozone against 2.4 per cent and 2.1 per cent respectively in 2007 due to soaring energy and food prices. The inflation is expected to come down to 2.4 per cent in 2009 and 2.2 per cent in the euro area. The Commission has projected the public deficit to deteriorate in 2008 and 2009. The 2008 overall deficit is foreseen to increase to 1.2 per cent of the GDP in the EU and 1 per cent in the eurozone but in 2009 the deficit should broadly stabilise.

According to the Commission’s spring economic forecast, the foreseen economic slowdown will also have a negative impact on the public debt of Member States. Things do not look well, in particular for the UK. The Commission has pointed out that “the significant depreciation of the pound's nominal effective exchange rate (by over 11 per cent between August and March) is likely to improve the price competitiveness of UK exports” whereas “at the same time aggravating inflationary risks in the short term.”

Moreover, the Commission envisages “a marked slowing of private consumption in 2008, driven by more restrictive borrowing conditions and a downward correction in house prices, and only a limited recovery in 2009.” The Commission has stressed that “Whilst moderate earnings growth will support private consumption, employment growth will no longer do so as it slows to almost zero over the forecast horizon.” The Commission has stated that “growth in the UK economy is expected to slow to around 1¾ per cent in 2008.”

The Maastricht Treaty has set out the reference value for government deficit at 3 per cent of gross domestic product (GDP). Taking into account the Commission’s opinion the Council decides, by a qualified majority, whether an excessive deficit exists establishing a deadline for effective action to be taken. If no effective action is taken, the Council may give notice to the Member State in question to take measures to reduce the deficit. Then, if no effective action has been taken in compliance with a notice, the Council may decide to impose sanctions which take the form of a non-interest-bearing deposit with the Community.

According to the Commission’s spring economic forecast, the UK as well as France are not setting an example for budgetary discipline as the Commission foresees they will breach rules on public deficit. Outside the eurozone the Member States likely to perform worst are the UK, Hungary and Romania. The UK deficit is predicted to rise from 2.9 per cent of GDP in 2007/08 to 3.3 per cent in 2008 and 2009. It should be mentioned that in September 2005, the Commission initiated the procedure against the UK based on a general government deficit of 3.2 per cent of GDP in financial year 2004/05. In 2006/07 the deficit fell further to 2.7 per cent of GDP. Last September, the UK excessive deficit situation has been corrected and the Commission has recommended to the Council to abrogate its decision on the existence of an excessive deficit in the United Kingdom.

However, Joaquin Almunia has already announced that the Commission on 11 June will put forward a proposal opening an excessive deficit procedure against the UK for running a deficit on public expenditure over revenue, of over 3 per cent of its gross domestic product (GDP). However, the Council’s formal notices and sanctions do not apply to Member States which do not participate in the euro. Therefore, the launch of an excessive deficit procedure against the UK would be seen as a political embarrassment to Alistair Darling. The Commission should not interfere in UK public finances, especially taking into account the credit crunch. If the excessive deficit procedure goes through Alistair Darling might be forced to raise taxes to reduce the deficit.

The eurozone finance ministers debated on 13 May the growing deficits in different Member States which may be jeopardised as the Eurogroup aims to balance the budget. According to the Eurogroup declaration from 13 May the commitment accepted by eurozone Member States, in April 2007 (Berlin Agreement), to achieve budgetary balance by 2010 was relaxed. France, whose public deficit is estimated to rise to 2.9 per cent in 2008 and 3 per cent in 2009, was able to negotiate a delay for all eurozone Member States to eradicate their deficits by 2010. Portugal and Italy are also raising concerns. According to Europolitics, a diplomat has said “nobody believes that we will all be in balance by 2010.” Nevertheless, the Commission will launch an excessive deficit procedure against France on 2 June, one month before it takes over the EU presidency.

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