Société Générale: ‘Long Covid’ threatens economy – Risk of tough austerity packages

Of Eleftheria Kourtali

Economic scars are expected to narrow in the eurozone, both in terms of GDP and employment. However, The impact of the COVID-19 crisis on public finances will prove to be long-term and significant (long Covid), with the region’s public debt moving 15% higher and deficits unlikely to return to pre-pandemic levels in the next five years, as the Société Générale points out in its report today.

In this context, he adds, it is not surprising that fiscal consolidation is on the “table” for 2022 and beyond. EU fiscal rules are likely to return in 2023, leaving many countries in the process of excessive deficits (including Greece). However, not only is it unlikely that the rules will be strictly enforced again, but significant changes are expected (Green Golden Rule, simplification and change of the debt rule) which will be discussed by the end of 2023.

Long-term scars in public finances

More specifically, the French bank notes that, as most countries should see their GDP return to 2022 levels in 2019, comparing the 2022 budget variables with 2019 gives a good idea of ​​the impact of the COVID crisis. -19 in public finances:

Deficit: much way to normalize. The eurozone deficit will remain at 4% of GDP in 2022, compared to -0.4% in 2019. After the financial crisis, it took three years to reach below this level below 3% and six years to fall below 1%. . A total of 12 countries out of 19 will have a deficit of more than 3%.

Structural balance: It will be 3% higher than 2019, which means that 80% of the deficit worsening is structural. This is even more pronounced for Germany and Italy (90%) and France (80%), but less so for Spain (20%). In other words, Germany, Italy and even the Netherlands have seen their structural deficits rise much more than France or Spain.

Public spending explains most of the worsening deficit, with the largest increases in Germany, Italy and Portugal.

Debt: will be about 15% higher but unevenly distributed. Government debt fell by 5.5% in Ireland and by almost 20% in Spain and Malta. Italy and France are roughly in line with the euro area average, while Germany and the Netherlands are down 1%. Public debt will be over 60% in 13 eurozone countries and over 100% in 7 countries, with Greece being forced to implement the biggest reduction annually.

If they return, fiscal rules would lead to unrealistic fiscal consolidation

The Commission’s forecasts for public finances until 2023 are made on the assumption of no policy change. The Commission sees the government deficit falling below 3% of GDP (-2.4%). However, 7 countries (including France, Spain and Italy) would still have deficits of more than 3%. SocGen estimates that the government deficit will be around 2.6% of GDP, close to the Commission forecasts that the debt to GDP ratio will be over 60% and will not be sufficiently reduced (1/20 per year of the gap to 60%) in 9 countries (out of 19) and will be over 100% in 6 countries.

As a result, as the French bank points out, if EU fiscal rules are restored as planned in 2023, up to 10 countries (7 in terms of the deficit rule and another 3 in the debt rule) should be subject to the excessive deficit procedure.

SocGen points out that this could happen as early as next spring and not in 2023. Member States present stability programs (three-year budget plans) in April. The Commission will then assess the compliance of these plans with the fiscal rules and could issue a report in late May or early June proposing the start of the excessive deficit procedure in countries that violate the rules.

The Commission may also launch this process in November, as part of the evaluation of the 2023 budget plans. These countries will then be called upon to adopt tough fiscal consolidation programs.

Given the highest starting points for debt ratios, the application of the applicable debt rules (the gap between the debt ratio up to 60% to be reduced at a rate of 1/20 per year) would mean an annual debt reduction target of more than 6.5% per year for Greece, 4.5% for Italy, 3.5% for Portugal and 2.5% and 3% for Spain and France, SocGen.

However, the Commission has made it clear that the rules will not be re-enforced “blindly” and that instead the flexibility of the Stability and Growth Pact will be used, and will present guidelines on the implementation of the rules early next year. While several countries may be subject to an excessive deficit process, this may impose small restrictions from 2023.

A dramatic change in fiscal rules is needed

Given the low interest rate environment, public debt service ratios have fallen sharply, allowing eurozone countries to maintain higher debt levels. As a result, the measurements used to stabilize fiscal policy (the 3% deficit and in particular the 60% debt thresholds) are now outdated and will need to be revised and adjusted, according to the Société Générale. Most importantly, current debt rules and medium-term targets will impose extremely unrealistic fiscal consolidation packages in countries with high debt levels.

What should be the changes

Although not agreed, the introduction of a Green Golden Rule is possible, as noted by the French bank. The exclusion of green investments from deficit and debt calculations has reportedly been discussed in both Germany and the Netherlands as part of negotiations to form new governments. There also seems to be a broad consensus that simplification of the rules is required. Replacing the excessive deficit procedure with a simpler rule (eg the cost reference point) therefore seems feasible.

Finally, SocGen believes that the fiscal rules may change so that debt targets take into account the specificities of countries (in terms of debt level, demographics, etc.). This would allow for greater ownership and compliance with the rules. A longer period of time could be considered to bridge the 60% debt target (30-40 years).

However, changing the debt rule can face significant opposition, especially from “frugal” countries (Netherlands, Austria, etc.). Indeed, a group of eight countries – the Netherlands, Austria, the Czech Republic, Slovakia, Denmark, Sweden, Denmark and Latvia – insisted in September that they would only support the changes if they led to “simplifications and adjustments conducive to consistent, transparent and better implementation. the enforcement of the rules “.