EU Leaning toward an Expansionary Stance

The authors are economists of Shinhan Investment Corp. They can be reached at heekim@shinhan.com. – Ed.

EU extends suspension of SGP; expansionary stance likely to continue

The EU has once again extended the suspension of the Stability and Growth Pact (SGP) for another year. The decision indicates that: 1) EU member states will have more time to meet obligations of the pact, i.e., lowering budget deficit below 3% and public debt below 60% of their GDP; and that 2) fiscal expansion, albeit at a smaller scale, will likely continue in 2022.

Germany, Italy to raise government spending; SGP reform under debate

Succeeding Angela Merkel who had been a strong advocate of balanced budgets, Olaf Scholz of the Social Democratic Party has been sworn in as the chancellor to lead Germany’s new coalition government. As a result, we expect to see a change to the country’s tight fiscal policy going forward. Meanwhile, Italian Prime Minister Mario Draghi has once again called for a reform of EU’s fiscal rules, stating plans to keep the country’s fiscal deficit target above 3% of its GDP for 2023. Debate on the reform of the SGP is currently underway. Circumstances have notably changed since the pact was first established in 1997. Despite the rise in debt, the increase in interest burden remains relatively limited at present with interest rates kept at lower levels than the 1990s. Borrowing limits set by the SGP become an obstacle when government spending is needed to rekindle private investment activity after a slowdown.

Green industries to benefit; French election and Frugal Four risks remain

We expect increased government spending to focus on accelerating the green transition. Energy security in Europe has been under threat due to increasing tensions between Russia and Ukraine, in turn raising the importance of developing renewable energy sources. However, the French presidential election in April next year and opposition from the Frugal Four member states are risk factors that could limit overall fiscal expansion in the region. In France, the emergence of a strong far-right candidate and rising popularity of center-right challenger Valérie Pécresse are raising uncertainties for fiscal expansion after the election. Strengthening opposition from the Frugal Four states (Austria, Denmark, the Netherlands, and Sweden) could also hinder expansion efforts going forward. In the Netherlands, pragmatists advocating for a conservative fiscal policy won the majority of seats in 2021 general elections. With fiscal responses becoming less urgent alongside the easing of the COVID-19 crisis, calls for a responsible EU budget from the Frugal Four states could increase going forward.


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