Changes to European debt rules could have a major impact on bond markets - Liberty

Saturday, August 26, 2023

Changes to European debt rules could have a major impact on bond markets


The Eurozone will discuss changes to its fiscal rules. This is a task that can affect the market.

The Eurozone is set to unveil changes to its fiscal rules soon, which could have a significant impact on government borrowing costs and the region's bond markets.

The European Commission, the EU's executive body, is due next week to submit proposals to reform fiscal rules that have been in place for almost 30 years. The rulebook has been criticized for being too opaque, too difficult to implement, and poorly enforced.

Paolo Gentiloni of the Economic Commission for Europe said at an event in October that "with the overall aim of supporting debt sustainability and sustainable growth, simplification, strengthening national ownership and enforcement. An improvement in the quality of life will be a hallmark of the improved framework," he said.

Fiscal disparities between eurozone member states (which share the euro currency) have always been a controversial topic in the region, causing divisions among them.

To give just one example, France has repeatedly violated deficit rules and has never been fined despite the provisions of the law. This will ease the pressure on the small euro economy, which was beating its budget deficit target to correct its fiscal stance. At the same time, Germany and the Netherlands will blame the European Commission for imposing fines and not enforcing the rules.

However, the Covid-19 pandemic has created similar economic strains across the region, forcing governments to spend significantly more to tackle the health crisis. This led to an increase in public debt across the block. The fact that they are all facing this challenge has added weight to the idea that the fiscal rulebook needs to be updated.

So the main idea in revising the rules now is to allow euro countries to adjust their debt levels. At the end of the second quarter, government debt stood at 94.2% of GDP across the 19 member states. It jumped from 86% at the end of Q1 2020 to 99.6% at the end of Q1 2021. This is due to rising costs associated with the pandemic.

French Minister for the Economy and Finance Bruno Le Maire, European Commissioner for Economy Paolo Gentiloni, and President of European Central Bank Christine Lagarde.

The need to revise fiscal stances has become increasingly important in times of war in Europe, energy crises, and severe cost of living pressures.

The rulebook stipulates that no country should have more than 60% of its GDP (gross domestic product) in debt. The benchmark remains unchanged, according to the same official, who asked to remain anonymous as the details have not yet been made public.

However, given their debt ratios of over 150%, it is understandably difficult for Greece and Italy to comply with this standard. Germany's government debt was just under 70% of GDP at the end of 2021.

The official said the commission plans to conduct debt sustainability analyses for each country and plan a course of action to correct the country's fiscal situation. They have a precise timeline for doing so with milestones to be achieved during that period. Member States will have a say in preparing for this course of action.

However, the problem some capitalists have with the new plan is how the European Commission will implement it. Dutch Finance Minister Sigrid Kaag said in a letter sent to the European Commission last week and seen by CNBC that "the rules now leave room for discretionary decisions by the Commission and Council (which is made up of member states). I have a lot left,” he said.

She said this "causes the rules to be applied in an opaque and sometimes inconsistent manner, which needs to be addressed in future reviews." The message follows earlier comments made by Germany's Finance Minister Christian Lindner, who also hopes future changes will facilitate enforcement of the rule.

European Commission Vice-President Valdis Dombrovskis.

Market players will be watching closely for details and how the discussion develops in the coming months. “The interest burden relative to GDP on huge public debt is set to increase significantly over the next few years. It is important to implement simpler yet credible rules to ensure the sustainability of public debt while managing public debt.”

European governments face higher costs in tapping the market as interest rates normalize. This marks a significant change from the ultra-accommodative monetary policy that has been in place in the Eurozone over the past decade.

Italian 10-Year Yield, For example, government bonds traded at 4.463% on Thursday. From 2020 to 2021, the same yield was almost below 2%. Henry Cook, the economist at MUFG Bank, said: "Ideally, the updated fiscal rules would provide much more flexibility related to the individual circumstances of each member state, as well as credible sanctions for serious violations. I will be able to receive it," he said.

"The most likely outcome is that the EU will continue to be in turmoil, with a lot of discretion given to national governments over their fiscal choices," he added. Any indication that countries are not committed to correcting their fiscal stances could push up borrowing costs even further. Regardless of the details to be announced next week, a lengthy debate is likely to begin between eurozone finance ministers.

This means that fiscal rules will change after 2024 in the best-case scenario. Another EU official, who did not want to be named on the grounds of the sensitivity of the upcoming talks, will be scheduled ahead of the 2024 EU parliamentary elections, and thus before the political debate centers around the vote. said it needed an agreement.