Commission Assesses Stability and Convergence Programmes of Bulgaria, the Czech Republic

IP/09/273

Brussels, 18 February 2009

Commission assesses Stability and Convergence Programmes of Bulgaria, the Czech Republic, Denmark, Germany, Estonia, Hungary, the Netherlands, Poland, Sweden, Finland and the United Kingdom

Today the European Commission examined the updated Stability and Convergence Programmes[1] of 17 EU countries including Bulgaria, the Czech Republic, Denmark, Germany, Estonia, Hungary, the Netherlands, Poland, Sweden, Finland and the United Kingdom (see IP/09/274 for separate programmes). These assessments are seen against the background of a sharp economic slowdown. A majority of the countries concerned (the Czech Republic, Denmark, Germany, the Netherlands, Poland, Sweden, Finland and the United Kingdom)have adopted fiscal stimulus measures in 2009 to cope with the economic crisis, in line with the Economic Recovery Plan proposed by the Commission and endorsed by EU leaders. In the UK, the expansionary measures coupled with the adverse impact of the downturn have significantly weakened the country's budgetary position.Hungary has made considerable progress to put its public finances on a sounder footing and needs to sustain this effort to secure investor confidence. Similarly, in Bulgaria and Estonia, the fiscal policy stance is appropriately geared towards diminishing macro-economic imbalances.

"We are going through a very serious crisis that is taking its toll on public finances. Fortunately, many countries have entered the crisis with public finances in a solid position, allowing them to the respond to the European Council's call for stimulus measures in 2009. Implemented swiftly and effectively, these measures should help to create, together with the bank rescue plans and the significant easing of monetary policy, the conditions for a gradual recovery in the second half of the year. If in 2010, as we believe, economic activity gathers momentum, fiscal policy needs to revert to a consolidation path. This is also important for Member States which are in a relatively favourable position in order to avoid a permanent deterioration in the sustainability of their public finances. In this context it is important that the Stability and Growth Pact remains the framework within which the Commission and the Council advices Member States on their conduct of fiscal policy",said Economic and Monetary Affairs Commissioner Joaquín Almunia.

BULGARIA

The programme's medium-term budgetary strategy aims at maintaining a sound budgetary position reflected in the high targeted general government surpluses of 3% of GDP throughout the programme period (2008-2001).

GDP growth has been high in Bulgariaat over 6% per year since 2003, accompanied by a widening external deficit and high inflation. As the impact of the global economic slowdown and financial crisis unfolds, Bulgaria faces the challenge of sustaining growth while addressing the existing macroeconomic imbalances through maintaining tight fiscal and income policies.

Bulgaria's fiscal policy is geared towards maintaining investor confidence and preserving macro-economic stability. The government's focus on structural measures to strengthen the economy's resilience also represents a timely and adequate response to the current economic outlook.

In view of the above assessment and also given the need to ensure sustainable convergence, Bulgaria is invited to: (i) continue maintaining a sound fiscal position by restraining expenditure growth, with a view to help contain existing external imbalances and counteract possible revenue shortfalls; (ii) contain public sector wage growth in order to contribute to overall wage moderation and improve competitiveness; and (iii) further strengthen the efficiency of public spending, in particular through full implementation of programme budgeting, reinforced administrative capacity and reforming the areas of labour and product markets, education and healthcare, in order to increase productivity and reduce the external deficit.

THE CZECH REPUBLIC

Starting from relatively low government deficit and debt levels, the programme targets a general government deficit of 1.6% and 1.5% of GDP in 2009 and 2010 respectively, based on favourable growth assumptions.

Against the background of the recent improvement in public finances, the CzechRepublic adopted a sizeable fiscal stimulus package. This package is in line with the EU Recovery Plan, in being timely and well-target to sectors of the economy likely to be most severely affected by the slowdown. It will be important to reverse them once economic conditions improve.

While pension and health care reforms have been introduced that will reduce expenditure, concerns remain regarding long term fiscal sustainability due to a rapidly ageing population.

In view of the Commission assessment, and also given the need to ensure sustainable convergence, the Czech Republic is invited to: (i) implement the measures in line with the EERP as planned.; (ii) reverse the adverse budgetary impact of the fiscal stimulus once the economy recovers and back-up the budgetary strategy with specific measures for reducing expenditure in 2010-2011 and (iii) continue with the necessary pension and health care reforms, given the projected increase in age-related expenditures, in order to improve the long-term sustainability of public finances.

DENMARK

After a period of strong economic activity and sizeable budgetary surpluses, Denmark's economic slowdown in 2008 was rapid and pronounced, as the cyclical downturn has been exacerbated by the global economic and financial crisis.

At the current juncture and given the comfortable fiscal position, the overall fiscal stance is considered adequate in view of the discretionary fiscal expansion in 2009 and the relatively strong automatic stabilisers at play.

The government debt has been nearly halved in the present decade to a low of 26.3% of GDP in 2007, thanks to high budgetary surpluses benefiting from a strong fiscal framework.

In view of the Commission assessment, Denmark is invited to (i) implement the planned measures in line with the European Recovery Plan and (ii) identify the required structural reform measures to achieve its budgetary targetsin the outer years of the programme.

FINLAND

After GDP growth above potential in 2006 and 2007 (4.9% and 4.2% respectively), the Finnish economy deceleratedrapidly in 2008 and is expected to be negative this year. The Finnish Programme submitted mid December still envisaged GDP growthof 0.6 % in 2009, but this appears optimistic given the deteriorated outlook in the past months.

The fundamentals of the Finnish economy are sound, though, with a significant surplus in both the current account and the public finances. Thanks to a prudent fiscal policy in the good times, Finland is expected to continue recording surpluses in general government finances during the programme period although they could turn less important than projected.

The programme envisages a large fiscal stimulus over 2009 and 2010, complemented by new measures announced in January. This appears appropriate, provided that action will also be taken to ensure fiscal retrenchment once the economic crisis abates in order to preserve the long term sustainability of the public finances. The public debt is expected to increase somewhat from an estimated figure of less than 33% in 2008.

In view of the Commission assessment, Finland is invited to: (i)implement the measures in line with the Recovery Plan and; (ii) reverse the adverse budgetary impact of the fiscal stimulus measures once the economy recovers in order to preserve the long-term sustainability of public finances.

GERMANY

After successfully reaching a close-to-balance budget in 2007 and 2008, Germany faces a deterioration in its public finances due to overall worsened economic situation and as a result of the steps undertaken to counter the sharp slowdown caused by the global economic and financial crisis.

The Stability Programme completed at the end of January, foresees a budget deficit of 3% of GDP in 2009 and 4% of GDP in 2010. Budgetary consolidation would be resumed after 2010 with the deficit falling to 2½% in 2012. Given the sharp deterioration in the global economy and distress in the financial sector, the budgetary strategy is subject to downside risks.

Using the room of manoeuvre afforded by the budgetary consolidation during the good times,Germany adopted a sizeable fiscal stimulus package between the autumn 2008 and January 2009 in line with the EU Recovery Plan. The stimulus focuses on income support, public and private investment, access to financing, avoiding lay-offs, improving qualifications and providing measures that support the automotive industry. It is a timely and targeted response to the economic crisis, commensurate with the scale of the downturn.

But it is also important to ensure a return to a credible fiscal consolidation path once the economy recovers. In this sense, the envisaged new constitutional rule limiting federal government structural deficits to 0.35% of GDP and the debt repayment schedule are important steps. Given increasing public debt, recent ad hoc changes to the pension adjustment formula and uncertainty as to the impact of the health-care reform, preserving the achievements made to improve long-term sustainability is critical.

Therefore, Germany is invited to (i) implement the measures in line with the Recovery Plan as planned and reverse the budgetary impact of the fiscal stimulus measures in order to support budgetary consolidation once the economy recovers; (ii) strengthen the institutional fiscal framework by implementing the new budgetary rule as currently envisaged in order to underpin the necessary consolidation course after 2010; (iii) give renewed attention to measures strengthening the long-term sustainability of public finances and ensure that the deviation from the pension adjustment formula in 2008 is reversed as envisaged.

ESTONIA

After many years of strong growth, Estonia is experiencing a severe downturn. The global financial crisis and weakening external demand have added to the reversal of the cycle and speeded up the contraction of the economy. While external and internal imbalances are now clearly subsiding, the loss of cost competitiveness accumulated over the years of wage growth well in excess of productivity growth hinders an orderly economic adjustment.

Following the updated Convergence Programme's submission in early December, more recently-announced measures aim at keeping the general government deficit below 3% of GDP. The expenditure cuts, which include a reduction of the public sector wage bill, are intended to support the adjustment process and strengthen the competitiveness of the economy. This is a welcome development that anticipates the policy invitations put forward by the Commission (see below). Recent modernisation of the labour law is also a timely step to improve the responsiveness of labour market. The Estonian authorities should now ensure that these measures are implemented.

In view of the Commission assessment and also given the need to ensure sustainable convergence and a smooth participation in ERM II, Estonia is invited to: (i) strengthen the consolidation of public finances in the short term to keep the general government deficit below 3% of GDP and take necessary measures to underpin the consolidation in the medium term; (ii) implement prudent public sector wage policies to support the adjustment of the economy and to strengthen competitiveness; (iii) reinforce the medium-term budgetary framework, particularly by improving expenditure planning and efficiency.

HUNGARY

In spite of distinct improvements in its high imbalances, including the reduction in its budget deficit from 9.3% in 2006 to below 3½% in 2008, Hungary has been particularly exposed to the financial crisis due to still high levels of government and external debt.. Thus, to restore investor confidence Hungary adopted a policy of further fiscal adjustment and tighter deficit targets.

The updated Convergence Programme submitted in December is based on the economic policy programme adopted by the government in response to the financial crisis and supported by international financial assistance, including a €6.5 billion loan from the European Union.

The programme foresees a continuation of the front-loaded budgetary consolidation strategy, with another important reduction in 2009 to 2.6% of GDP. Thereafter, it plans a more moderate progress towards a deficit of 2.2% in 2011. In view of the recent substantially deteriorated macroeconomic outlook and the related budgetary risks, the government adopted on 15 February an additional corrective package of 0.7% of GDP and slightly revised its 2009 deficit target upwards.

The sustainability of public finances hinges on the continuation of structural reforms, as recently announced, to the extent that they increase long-term growth, help meet budgetary targets, and reduce the country’s vulnerabilities.

Given this assessment, Hungary is invited, (i) in view of the risks, maintain adequate buffers, take the necessary measures to keep the budget deficit below 3% of GDP and ensure that adequate progress in budgetary consolidation is made, thereby setting the debt-to-GDP ratio on a declining path towards the 60% of GDP threshold. (ii) ensure full implementation of the fiscal responsibility law and continue the expenditure moderation through additional structural reforms and strengthen financial market regulation and supervision. Finally, (iii) Hungary is invited to further improve the long-term sustainability of public finances namely through a continuation of the reforms in the pension system.

THE NETHERLANDS

Economic activity is expected to decrease sharply in 2009, as the Netherlands is set to be severely hit by the sharp fall in world trade and the financial crisis.

The Stability Programme submitted in November and updated on 18 December aimed at achieving and maintaining stable budgetary surplus between 2008 and 2011, but this scenario is subject to risks linked to the evolution of economic growth and gas prices as well as the risks associated with the sizeable guarantees given to the financial sector. However, and despite the increase in the public debt to 57% of GDP at the end of 2008 (due to the rescue plans to the financial sector), the main challenges lie in addressing the low confidence in the financial sector and supporting investment.

The Dutch government adopted two support packages, in November 2008 and January 2009, aimed at fostering private investment, protecting employment and improving credit supply. The measures are in line with the European Recovery Plan (timely, temporary and targeted), but their budgetary impact is rather limited.

In view of this assessment, the Netherlands is invited to implement measures in line with the European Recovery Plan.

POLAND

Poland's strong GDP growth is expected to slow markedly in 2009 mainly due to the impact of the global financial crisis, through the deterioration in global trade flows, the slowdown in FDI activity and the limited availability of external financing.

The updated Convergence Programme sent at the end of December targets a general government deficit of 2½% of GDP in 2009, based on rather favourable growth assumptions. Further ahead, the programme targets a budget deficit of 2.3% of GDP in 2010 based on expenditure restraint about which there is presently little information.

Poland is planning adequate fiscal stimulus measures, some of which are not temporary, which will stimulate both aggregate demand in the short term and strengthen the supply side of the Polish economy in a longer term. In line with the European Recovery Plan, the fiscal stimulus measures adopted by Poland mostly contemplate increased public investment in infrastructure as well as some cuts in income taxes which reduce the tax wedge.

In view of the Commission assessment and also given the need to ensure sustainable convergence, Poland is invited to: (i) implement the stimulus measures in line with the Recovery Plan as planned, while ensuring that the deficit remains below 3% of GDP in 2009; (ii) back up the budgetary strategy with specific deficit-reducing measures for 2010 and 2011; (iii) reinforce the budgetary framework through better control over expenditure, including the swift implementation of the amended public finance act and performance budgeting.

SWEDEN

After a prolonged period of relatively strong economic growth, Sweden is experiencing a sharp economic slowdown, which will negatively affect its budget balance this year.

However, the medium-term budgetary position of Swedenis sound. Large surpluses in good times have created space to allow fiscal policy to play an active role in the current downturn, not only by boosting demand in the short term but also by strengthening the economy's long-term growth potential.

The fiscal stance has appropriately become expansionary in 2009. However, there are short-term risks to the fiscal balance, and there is a need to strengthen the fiscal framework to ensure that the government balance improves once the economy picks up again.

In view of the Commission assessment, Sweden is invited to (i) implement the measures in response to the EERP as planned;(ii) reverse the adverse budgetary impact of the fiscal stimulus measures once the economy recovers.

THE UNITED KINGDOM

The United Kingdom's convergence programme update, submitted on 18 December, confirms a rapid deterioration in the UK’s budgetary position that has considerably strained the sustainability of its public finances. The probably significantly weaker-than-envisaged outlook in the near term also entails the risk of higher government deficits throughout the programme period.

Following the rapid worsening in the macroeconomic situation, the government deficit is estimated in the programme at 5½% of GDP in 2008/09 and is forecast to peak at 8.2% in 2009/10. The budgetary projections include the cost of the fiscal stimulus package announced in November 2008.