Brussels Gets a Slap on the Wrist from … Brussels

On Wednesday, the EU again demonstrated political rules will be reshaped if it means greater stability in the single market and currency, which should further assuage fears of a sudden eurozone split. This further reduces a potential negative for global stocks and could further bolster sentiment incrementally, though it likely does little to fundamentally buoy the eurozone’s economy and markets relative to peers.

The Brussels-based European Commission (EC) released new deficit targets for the 20 countries subject to its Excessive Deficit Procedure, and lo and behold, several countries suddenly find themselves with greater deficit wiggle room. Due to weaker-than-expected growth and the “effective actions” they’ve already taken to rein in deficits, France, Spain, Poland, Slovenia and The Netherlands get more time to bring their deficits under 3% of GDP. That suggests officials are still quite flexible when it comes to debt reduction plans for participant countries—a form of kicking the can on these arbitrary political constructs.

Overall, the changes ease the political pressure on most EU countries, perhaps letting them bypass significant tax hikes—a relief for their struggling private sectors. That likely isn’t a panacea for the eurozone economy or equities—in many European countries, competitiveness reforms are critical to future growth trajectories, while deficit levels much less so. But easing fears and reduced calls for increased taxes could boost investor sentiment a bit—it also buys more time for these nations to push economic reforms.

However, EU officials didn’t give everyone a free pass—they zinged Belgium for failing to reach its mandatory budget limit of 3% of GDP for 2012. The country dodged a rumored fine, which EU Economy Commissioner Olli Rehn stated would “go against the non-retroactivity” element in European law since Belgium didn’t have a government from 2010 to 2011. But it has to meet the deficit target by year end, and it will be subject to quarterly progress reviews.

In our view, the heightened focus on Belgium is rather headscratching, at least from an economic standpoint. Its 3.9% deficit—tame by most standards and well under the recent high of 5.6% in 2010—stemmed largely from bailing out Dexia, the Franco-Belgian bank. Besides the one-time expense (which cost 0.8% of GDP), Belgium likely would have barely missed its target. One would think Belgium would get positive recognition for the progress, but EU officials seemed keen to make an example of someone, flex some muscle and goad the rest of the region into cutting back. Maybe that gambit works and more countries make bigger fiscal adjustments, but that’s not automatically good. Deficit targets are more political than economic—there’s nothing magical about that 3% threshold. What matters more is what the policies and conditions leading to the deficits are and how countries try to tackle them.

Perhaps, with somewhat easier deficit targets, at least some eurozone nations can give people and businesses a bit of tax relief. Spain, for example, has said it plans to cut taxes a bit within the next couple years. Plus, the EC’s recommendations aren’t ironclad. EU finance ministers will discuss them at their June summit, and at least some nations (like France) probably lobby for additional flexibility—these targets could very well get watered down further. That said, we expect the slow-go growth trend to continue for some time in the eurozone—easier targets just buy the region more time to muddle through.