BRUSSELS (MNI) – European governments struggling with stalling
economies and soaring borrowing costs cannot afford to miss their
deficit reduction targets even if macroeconomic conditions turn out
worse than expected, the European Commission warned on Wednesday.

Those countries must find ways to pursue fiscal consolidation
without crushing growth, the Commission said.

In a blow to hopes that the Commission might show some flexibility
on fiscal targets, the EU’s executive body said in an analysis released
Wednesday that “member states which face high and potentially rising
risk premia do not have much room for manoeuvre to deviate from their
nominal fiscal targets, even if macroeconomic conditions turn out worse
than expected.”

Heavily indebted governments need to cut spending as a
“precondition to underpin credibility and prevent risk premia from
rising further,” it said.

The pace of consolidation, however, should vary across the Eurozone
because “the size of fiscal challenges differs among the euro area
member states and calls for differentiated speed of consolidation,” the
Commission said.

Governments need to reduce their high public debt “in the context
of credible medium-term fiscal consolidation strategies, which strike
the right balance between the need for consolidation, reform and
growth,” the Commission said.

To prevent fiscal consolidation from damaging the economy,
governments should make sure they cut overall spending and if necessary
raise taxes in a “growth friendly way” by, for example, prioritizing
public expenditure that supports growth and avoiding the most
growth-suffocating taxes, such as labour taxes, in favour of taxes on
consumption and property, the Commission added.

Only a few European governments, such as Italy, Germany and
Portugal, have safeguarded growth-friendly expenditure in areas such as
research, education and infrastructure, while many, including Austria,
France and Spain, have relied too heavily on raising the wrong kinds of
taxes, the Commission said.

“Growth-friendly consolidation also requires prioritizing
growth-supporting public expenditure so as not to undermine the already
weak growth potential of the euro area economy,” the Commission’s
analysis said. It added that “public investment has particular
importance in this respect since investment expenditure increases growth
via domestic demand in the short term, while having a positive effect on
the supply side in the long term.”

In a message that could be aimed at Germany, which has seen its
cost of funding drop, the Commission said that this logic was especially
relevant in “member states which face extraordinarily low interest

In a speech in Brussels on Tuesday, European Commission President
Jose Manuel Barroso hinted that the Commission might examine the
possibility of treating government expenditures differently depending on
their “quality.”

Italian President Mario Monti has been heavily promoting a plan to
allow governments to lower their official debt to GDP ratios by treating
public expenditure on investment differently from other public debt.


In its analysis, the Commission argued strongly that Eurozone
governments should consider some form of collectively-issued sovereign

Departing from its previous position that collectively-issued bonds
could only be considered once fiscal policies across the Eurozone were
sufficiently integrated, the Commission said Wednesday that “budgetary
discipline and solidarity in the euro area could also be fostered by the
common issuance of sovereign debt instruments.” It added: “Creating a
new market segment based on common issuance would address the current
shortage of investor demand for the sovereign bonds of many euro-area
member states.”

Depending on the exact nature of the scheme, the ability to issue
common ‘Eurobonds’ would provide governments “with more secure access to
refinancing at a generally lower rate through a lower liquidity premium
and less market volatility.”

“Even if common issuance were not to play a role in managing the
sovereign debt crisis, such an instrument would contribute to efficient
financial integration by facilitating the transmission of monetary
policy and making available high-quality collateral that can be more
easily used on a cross-border basis,” the Commission argued.

Jointly-backed bonds would only be helpful, however, if the
“potential disincentives for fiscal discipline can be controlled,” the
Commission said.

For the first time, the Commission also stated clearly that the
enhanced fiscal and economic surveillance rules agreed by Eurozone
governments since the start of the crisis “may be a significant step
towards fulfilling the preconditions for common issuance.”


Analysing the effects of the European Central Bank’s cheap
three-year loans to the banking sector, the commission said that the
“extraordinary liquidity measures have given the banks a breathing
space,” alleviating “acute funding strains in the banking sector” and
allowing banks “to provide lending to the economy once economic
conditions improve.”

However, the fact that some banks used these “Very Long-Term
Refinancing Operations” (VLTROs) to buy the higher-yielding debt of
their own governments has contributed to a further deepening of the
less-than-desirable “interconnectedness between banks and sovereigns.”

“Thus, it is of paramount importance that the window of opportunity
offered by the VLTROs is used by banks to proceed with financial repair
and restructuring of balance sheets, while maintaining credit flow to
the economy, so that a more resilient banking sector is in place when
the VLTROs come to maturity,” the Commission said.

–Brussels Newsroom, +324-952-28374;

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