A decade ago, bond markets buffeted the euro. Banking troubles in Greece and Cyprus were serious. Bank accounts were frozen in Greece in 2015, with limited withdrawals. In Cyprus in 2013 some euro depositors suffered enforced reductions in the value of their deposits in so-called buy-in bank restructurings. The euro system was not prepared to stand behind all the commercial banks in the system without conditions on making more euros available.
There was also a general problem of excessive debts and deficits by several countries. States were made to rein in budget deficits by the European Union (EU) aided by bond markets willing to raise borrowing rates substantially for a country struggling to control its own finances.
Since the resolution of those crises, the EU and European Central Bank (ECB) have been more cautious in their approach to member states not complying with euro rules laid down in the treaties. The ECB has been keen to try to keep member states borrowing rates closer together, despite the very varied performance over keeping budget deficits and debts down.
What the treaty says
The EU is a complex legal structure, with a rules-based governance that controls the institutions and the system. Treaty Clause 126 sets out a requirement that member states keep their deficits and total debt below specified maximum limits. The limits are fixed in Protocol 12 of the treaty at 3% maximum for an annual deficit and 60% of gross domestic product (GDP) maximum for state debt.
Article 126 gives the EU powers to require excessive deficits to be reined in and to demand that state debt be brought down to the limit level. The EU can require more information from the state, can withhold European Investment Bank loans, can demand the member state deposits money in a non-interest-bearing account with the EU, and can levy fines. The two toughest actions in the short term make the deficit worse.
Current excessive deficit procedures
Eight member states are currently subject to excessive deficit procedures. Italy, Belgium, France, Poland, Hungary, Romania, Malta and Slovakia are all struggling to control debts and deficits. Many EU countries have remained above the 60% state-debt-to-GDP level and have been urged to get their state debts down. Greece. at 164% of GDP, Italy (135%), France (112%), Spain (109%), Belgium (108%) and Portugal (107%) are the highest, at more than two thirds over the limit.
France is the most immediate worry. The country has got away with running deficits of more than 3% for 19 of the last 22 years. This time, there is more serious EU pressure.
As a result of many years of big additional borrowing the total state debt keeps moving higher and higher, above the 60% target. Having a member state with no effective government to put through a budget is a problem France shares with Belgium, where five months on from an inconclusive general election there is no government formed in parliament. Germany has a caretaker government without a majority pending a federal election.
President Macron's problem
President Emmanuel Macron held an early election this summer, only to see his supporter parties lose badly. Instead of getting a more helpful parliament, France voted for three very different blocs, where the president's critics from the left and the right outnumber his supporters. His wish to unite France came true in the way he did not want. He has united a majority of parties and voters against his government.
The president has made it clear that he intends to serve his full term in office until May 2027. He cannot order a new parliamentary election before July 2025. His latest prime minister has been defeated in a confidence motion arising out of the budget proposals.
The parliament could take the extreme measure of impeaching the president, which needs a two-thirds majority and the ability to overcome a legal hurdle, but so far there is no sign of a majority of members of the National Assembly wishing to try this. In his address to the nation, President Macron blamed the parliament for its unruly behaviour. Many wanted more contrition from the President for what they see were his mistakes. The parliament blames him for not leading enough of the people and parties for enough of the time in a direction they will accept.
What happens next in France?
A new prime minister will be appointed who will also find it difficult to win votes in parliament. Some other parties and the Macron-supporting parties may agree a 2025 budget based on the 2024 one, with a finance law passed to allow continuing collection of tax revenue. This will delay progress to cutting the deficit as the parliament cannot agree on spending cuts and or tax increases to make a decent dent in the deficit. This leaves the EU with a major problem, as France will not be seriously engaging with deficit reduction.
What will the EU do?
When there are big disputes with major countries such as France and Germany, the EU usually delays and compromises. It would be surprising if the EU upped the tensions by fining France for non-compliance. The EU must work with all eight countries breaking budget rules and get what wins it can, given the member state political constraints. The whole EU deficit reduction policy is often called austerity and is now part of the reason some governing parties around the EU get voted out.
What will the ECB do?
The ECB is playing things down, refusing to lecture France or say anything that might make things worse. ECB President Christine Lagarde says she will not comment on individual member states budgets, which belong to the realm of national politics, though she has backed a German proposal to increase their state deficit to invest more.
The ECB has implied it will use its powers to guide markets against big rises in the borrowing rates for high deficit countries as it sees big spreads as unhelpful. The ECB will assist deficit countries through its Target 2 balances and by helping heavily indebted countries borrow at lower rates than if they were independent of the euro system.
The underlying problems
The EU is not growing quickly enough, falling further and further behind the US. Citizens want high welfare levels and good public services, but do not want taxes to go any higher.
Governments complain that they cannot reconcile the need to spend and the need to cut taxes. They resort to more borrowing. As interest costs rise, so budget pressures get worse. Electors are frustrated in many countries by lack of growth and by high taxes. It makes it difficult for incumbent governments to win elections and gives support to many new challenger populist parties.
Conclusions
Since the end of the euro crises a decade ago, both the European Commission and the ECB have got better at managing debt rows and interest rates. They have largely done so by being more tolerant of deficit overruns, accepting permanent levels of debt massively over clear treaty limits.
The issue now is whether markets continue to give the high debt and deficit countries the benefit of the doubt, because the EU is to some extent subsidising them and wants their stability. So far, this has worked. France is now unable to put through a budget, Italy is very dependent on EU grants and other countries pushing the boundaries of the excessive debt system. This means risks have increased. Many countries are under EU pressure to run more restrictive fiscal policies.
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