Solbes signals thaw in hardline approach to budget austerity

Date: 18/11/1999

By Tim Jones

GOVERNMENTS are entitled to take advantage of a speed-up in euro-zone growth to cut taxes or boost public investment after years of austerity, according to the European Commission's economic policy chief.

Pedro Solbes' comments signal a thaw in the hardline policy pursued until September by his predecessor Yves-Thibault de Silguy and contradict the European Central Bank's credo that 'windfall' revenues from stronger-than-expected growth should be used to bring budgets into balance.

"You cannot adopt the same position when deficits are over 5% of gross domestic product and where they are now," Solbes told European Voice as he prepared to unveil his staff's revised economic forecasts for the EU next Wednesday (24 November).

These are expected to show that the aggregate euro-zone budget deficit will narrow to around 1.6% of GDP this year and 1.2% in 2000, in line with Organisation for Economic Cooperation and Development forecasts published this week.

This is well below the 3%-of-GDP ceiling laid down under euro-zone rules. In its March forecasts, the Commission predicted that the deficit would narrow to 1.9% of GDP this year and 1.7% in 2000.

Solbes will also revise upwards the Commission's economic growth forecast for next year, from 2.7% to between 2.8%-3.0%.

The pick-up has already boosted governments' tax revenues and reduced their social-security spending. "The better evolution of the deficit is definitely connected with additional revenue coming from an improved cyclical situation," said Solbes.

"The very orthodox position would say that you have to use this additional revenue to reduce the deficit. My position is: if you have already advanced sufficiently well from the point of view of the deficit, you could use a part of this money either to reduce taxation or to increase public investment. We have to continue with fiscal consolidation; the question is whether we arrive at fiscal consolidation next year or a year after."

This is a highly-sensitive issue in most euro-zone member states. The Dutch government faced withering criticism from the national central bank after it opted for tax cuts worth €2.2 billion in 2000 instead of balancing the budget. The Italian centre-left coalition's budget for next year includes €2 billion in tax cuts and spending hikes even though it was forced to ask the Union's permission earlier this year to raise its 1999 deficit target from 2.0% of GDP to 2.4%.

"Italy is a clear example of a country that has to continue with consolidation of the fiscal deficit," said Solbes. "What they have to do first is regain the path they set in their stability programme. I think they will be able to do a little bit better than 2.4% of GDP this year."

Solbes acknowledged that it would be risky for governments with deficits close to the 3%-of-GDP ceiling to take their foot off the brake. "If you have a deficit position of 1%, then it is clear you can do other things but at 2%, a sudden change in the cyclical situation could be a risk," he said.

Next week's Commission forecasts are expected to show that France, Austria and Portugal will have deficits worth more than 1.5% of GDP in 2000.

Solbes said he was "not so sure the inflation figure will be modified" in the revised forecasts, despite the ECB's decision to raise interest rates by 0.5 of a percentage point to 3.0% this month.

In March, the Commission forecast that annual inflation would average 1.5% in 2000 but, since January, average oil prices have risen by 37%. However, Solbes believes that "the risk of inflation is not great".

Next week, the Commission's economic and financial affairs directorate-general will release its annual report on the EU economy to coincide with the forecasts for the first time.