Role of the EU budget in macro-financial stability

No instrument was set up to address the impact of imbalances in the eurozone and the financial crisis has revealed the eurozone weaknesses in this respect. The EU budget was and still is not designed to handle such shocks and has been largely ineffective in responding, even if a number of ad hoc measures have been introduced.

Consequently, Europe has paid dearly for the lack of a fiscal and budgetary capacity of the EU to address imbalances in the single market and the eurozone when hit by the crisis. The lack of coordination and the long lag in devising responses have most likely deepened the crisis and slowed down recovery.

Many problems in the eurozone area were to be expected – the need for an appropriate instrument for a single currency area has been well documented and the findings of the 1977 MacDougall report are as valid today as they were then (MacDougall et al., 1977). Many analysts have subsequently confirmed this, before and after the shock of the crisis. The introduction of the euro has taken place without a fiscal support structure to handle imbalances in the eurozone.

With funding pre-allocated geographically and committed to support automatic payments in sectors (agriculture) or multiannual programmes in regions, it simply is largely inappropriate to mobilise funding rapidly where needed to stabilise markets, refinance banks and rescue governments from BoP crises. Once the financial crisis hit the EU, it became apparent that the design and inflexibility of the budget made it ineffective as a response mechanism for the imbalances in the eurozone. This inflexibility is visible in relation to both revenues and expenditures.

Nevertheless, and much to the credit of the European Commission, the limited margins of flexibility of the EU budget on the resources and the expenditure sides were used and stretched considerably, changing the co-financing rates for the worst stricken countries. But it remains a fact that the response to the financial crisis has been patchy, controversial and too limited. The EU was not equipped to react and the EU budget was not designed to handle any significant crisis, which, from a public perception point of view, has affected the image of the EU and its budget. Still, even if the EU budget had been larger or doubled in line with the MacDougall

report, and had a mandate to intervene, Obstfeld (2013) notes that banking systems have become too big for any national budget and thus also for the EU budget.

It is interesting to note the resilience of the EU budget resources and expenditure mechanisms in the face of the gravest financial crisis since 1929. It would have been rational to expect that given the exceptional circumstances and the existence of a budget review in 2010, one of the hardest years of the crisis, Member States would have agreed to seriously reform the own resources and the budget structure. That, however, has not been the case; the decision-making mechanism is designed in such a way that it creates strong disincentives for Member States to agree on radical changes.

The measures have been partial: on the expenditure side there have been reductions in the co-financing requirements for Greece in the Cohesion Policy, some limited reallocation of resources between headings and the introduction of more budget guarantees for financial instruments. On the resources side, the use of present and estimated future EU budget margins has been increased as guarantees for macro-financial assistance.

While this flurry of partial measures is undoubtedly without precedence and ‘revolutionary’

compared with the usual state of affairs of the EU budget, they can hardly be seen as commensurate with the challenges faced by the EU. It is thus no surprise that separate, sizable mechanisms worth a multiple of the EU budget (e.g. the ESM) have emerged to face macroeconomic imbalances and that the idea of establishing a eurozone budget has been circulating.

11.4.1 The functioning of macro-financial instruments linked to the EU budget

Until the financial crisis, only two instruments for macro-financial stability existed, but only for eurozone Member States and EU countries – the BoP assistance mechanism for non-eurozone Member States and Macro-Financial Assistance (MFA), established in 2002 (Council Regulation (EC) No. 332/202). In fact, the BoP mechanism was adopted in 1988 (Council Regulation (EEC) No. 1969/88).⁶² The instrument was designed to intervene before the introduction of the single currency, which was expected to cancel the need for such instruments.

The Regulation only remained in force until 1999 with the entry of the euro. It was later reactivated in view of the enlargement and the risks of new Member States needing assistance. It was revived and amended in 2002 (Council Regulation (EC) No. 332/2002)⁶³ for non-euro Member States and with a support ceiling that was even slightly reduced compared with the original (€12 billion compared with the real value of €16 billion of the 1988 instrument).

The MFA instrument was specifically designed to support partner non-EU countries experiencing financial crises, and has been in action since 1990.

Both instruments are supported by the EU budget, but are largely unknown, as the implications for the expenditures are indirect and the financial mechanism complex and opaque. They represent, however, the model on which the first stability mechanism for the eurozone was based.

62 See Council Regulation (EEC) No. 1969/88 of 24 June 1988 establishing a single facility providing medium-term financial assistance for Member States’ balances of payments, OJ L 178, 8.7.1988.

63 See Council Regulation (EC) No. 332/2002 of 18 February 2002 establishing a facility providing medium-term financial assistance for Member States’ balances of payments, OJ L 53/1, 23.2.2002.

11.4.2 Legal barriers to stabilisation mechanisms

At the outset of the eurozone crisis, two legal provisions seemed to contradict one another on the role of a possible mechanism for eurozone fiscal stabilisation. On the one hand, the EU is required as specified in the Treaty (Art. 143 TFEU) to intervene when a country encounters financial difficulties or threats to its economic stability. On the other hand, the so-called ‘no bailout’ clause (Art. 125 TFEU) seems to prohibit EU assistance to eurozone Member States (or at least guarantees for their national debts). In effect, this has limited assistance to the non-eurozone members.

Eurozone members de facto considered (and against economic theory claiming the contrary) that the stability and growth pact (based on Arts. 121–26) would ensure the stability and effective budgetary oversight of the eurozone, something the crisis demonstrated to be untrue.

After various failed attempts to manage the impacts of the crisis without challenging the existing provisions, i.e. having Member States handle the crisis without coordination, the Member States agreed that additional specific mechanisms had to be designed. The Greek crisis had already forced the EU to take extraordinary action by launching the Greek loan facility. In 2010, and based on the mechanism in place for the BoP assistance, the EU introduced the European Financial Stability Mechanism (EFSM) (Council Regulation (EC) No. 407/2010).⁶⁴

These responses were clearly not sufficient to enable the eurozone to respond to the unfolding crisis. A temporary mechanism was created outside the EU budget, the European Financial Stability Facility (EFSF) by the eurozone Member States that provided assistance to Ireland, Portugal and Greece. The European Council adopted an amendment to the TFEU on 25 March 2011, adding a new paragraph to Art. 136: “The Member States whose currency is the euro may establish a stability mechanism to be activated if indispensable to safeguard the stability of the eurozone as a whole. The granting of any required financial assistance under the mechanism will be made subject to strict conditionality.” This amendment allowed the subsequent establishment of the permanent ESM that replaced the EFSF, also not linked to the EU budget.

What, however, are the implications of these mechanisms for the EU own resources? The BoP, EFSM and MFA have in common the fact that it is the EU budget that guarantees the support given. The European Commission (in accordance with the Council) is authorised to borrow on the capital markets or from financial institutions in order to finance the loans, as was the case with the BoP. This happens mainly by issuing notes under the Euro Medium-Term Note Programme. They are intended primarily for securities. EU assistance is of a medium-term nature – ranging normally from 5 to 10 years, but can go up to 15 years, according to the particular conditions of the loans.

Since the activation of the EFSM for Ireland and Portugal, the EU has become a frequent benchmark issuer (Figure 11-1): since 2011, around €54 billion has been raised through 15 issues of bonds. The funds raised are in principle lent back-to-back to the beneficiary country, i.e. with the same coupon, maturity and amount. Annual interest and principal obligations range from €1.3 billion in 2012 to a maximum of €10 billion in 2021.

64 See Council Regulation (EU) No. 407/2010 of 11 May 2010 establishing a European financial stabilisation mechanism, OJ L 118/1, 15.5.2010.

Table 11-1. EFSM operations Amount

(€ billion)

Maturity (years)

Raised on Beneficiary Disbursement on

5.0 5 5 Jan. 2011 Ireland 12 Jan. 2011

3.4 7 17 Mar. 2011 Ireland 24 Mar. 2011

4.75 10 24 May 2011 €3 billion for Ireland;

€1.75 billion for Portugal 31 May 2011

4.75 5 25 May 2011 Portugal 1 Jun. 2011

5.0 10 14 Sept. 2011 Portugal 21 Sept. 2011

4.0 15 22 Sept. 2011 €2 billion for Ireland;

€2 billion for Portugal

29 Sept. 2011

1.1 7 29 Sept. 2011 €0.5 billion for Ireland;

€0.6 billion for Portugal

6 Oct. 2011

3.0 30 9 Jan. 2012 €1.5 billion for Ireland;

€1.5 billion for Portugal

16 Jan. 2012

3.0 20 27 Feb. 2012 Ireland 5 Mar. 2012

1.8 26 17 Apr. 2012 Portugal 24 Apr. 2012

2.7 10 26 Apr. 2012 Portugal 4 May 2012

2.3 15 26 Jun. 2012 Ireland 3 July 2012

3.0 15 23 Oct. 2012 €1 billion Ireland;

€2 billion Portugal

30 Oct. 2012

2.6 10 18 Mar. 2014 €0.8 billion Ireland;

€1.8 billion Portugal

25 Mar. 2014

0.4 15 5 Nov. 2014 Portugal 12 Nov. 2014

7.16 15 – Greece 20 June 2015

Source: European Commission, DG ECFIN website.

How can the EU budget guarantee such operations? The BoP can lend up to €12 billion, but the EFSM can loan up to €80 billion and even be increased to €110 billion (European Commission, 2010c). The EFSM was designed for supporting eurozone Member States, but does not exclude support to non-eurozone countries.

The BoP and EFSM cannot be guaranteed by blocking the EU budget repayments for the year, given the considerable side effects on the budget appropriations within the budget ceilings for payments and commitments. That occurs only for the MFA, it is rather modest and the guarantee required is blocked yearly in the EU budget; thus, a default on a payment is secured without an impact on the EU budget size. But that is not the case for the BoP and the EFSM, which are guaranteed by the margin between the EU budget’s own resources ceiling of 1.23% of GNI and the payment appropriations. This margin cannot cover the whole loan, but the annual repayment default risk. Of course, the EU budget margin is limited every year and cannot grow to be an efficient lender for rescue packages as required. External mechanisms have therefore

been set up for the rescue packages. Those mechanisms, the EFSF and subsequently the ESM are or have been guaranteed directly by the Member States and imply no consequences for the EU budget, and hence are not discussed here.

11.4.3 Impact of the macro-financial instruments on own resources

The budget lines for the BoP, EFSM and MFA loans are listed under heading 01 04 01 (“European Community Guarantees for lending operations and for EIB [European Investment Bank] lending operations”):

 01 04 01 01 – European Union guarantee for Union borrowings for balance-of-payments support;

 01 04 01 03 – European Union guarantee for Union borrowings for financial assistance under the European Financial Stabilisation Mechanism; and

 01 04 01 04 – European Union guarantee for Union borrowings for Macro-Financial Assistance to third countries.

Each line includes references to the volumes, the duration and the basic acts. In addition, budget line 01 04 01 14 shows the sum of the “Provisioning of the Guarantee Fund” for all Union and Euratom borrowing operations and for EIB lending operations.

The risk exposure of the MFA is very limited, because it is recorded as part of the EU budget expenditures in the Guarantee Fund for external actions (as a safety net), which is also used to guarantee loans by the EIB to third countries. The amounts of the financial assistance provided in grants under the MFA must be consistent with the budget appropriations established in the MFF, in accordance with Council Regulation (EC, Euratom) 480/2009 of 25 May 2009 on the Guarantee Fund for external actions.⁶⁵

That is not the case for BoP and EFSM assistance. Here the EU budget sets aside the guaranteed annual repayment obligations of countries to the EU budget in the EU budget’s margin between payment appropriations and the EU budget ceiling. It is under a ‘token entry’ or pour memoria.

Thus, budget lines 800 for BoP and 802 for the EFSM have been created on the revenue side to account for any potential reimbursements after an initial default or for any other revenue arising in connection with the guarantee provided by the EU budget. In other words, if a default happens, the Member States must add to their EU budget contributions their share of the costs of a default in line with the own resource procedures.