The preventive arm of the Stability and Growth Pact aims to ensure sound budgetary policies over the medium term by setting parameters for Member States' fiscal planning and policies during normal economic times. Compliance with the preventive arm's provisions should ensure that the Treaty's limits (3% of GDP for the general government deficit and 60% of GDP for gross debt, where debt is also not diminishing at a satisfactory pace) are not breached over a normal economic cycle.
The medium-term budgetary objective (MTO)
The cornerstone of the preventive arm is the attainment of the medium-term budgetary objective (MTO). The MTO is a country-specific reference value for individual Member States' medium-term budgetary positions, defined in structural terms (that is, cyclically adjusted and net of one-off and temporary measures). All Member States must reach their MTOs or be on an appropriate adjustment path towards it, with an annual improvement of their structural balance of 0.5% of GDP as a benchmark. The MTO is determined to ensure a healthy underlying budgetary position. MTOs are updated every three years or more frequently if a Member State has undergone a structural reform significantly impacting its public finances. The reference value for the MTO should ensure that Member States
Member States should either be at their MTO or making rapid progress towards it. Member States faced with a debt level exceeding 60% of GDP or with pronounced risks to overall debt sustainability are required to adjust faster towards the MTO. For all countries, a higher adjustment is required in good economic times in order to have more flexibility in bad times. For euro area Member States and participants of the Exchange Rate Mechanism (ERM) II, the country-specific MTO must be specified within a defined range between -1% of GDP and balance or surplus, in cyclically adjusted terms and net of one-off and temporary measures. Euro area countries that are signatories to the Treaty on Stability, Coordination and Governance (TSCG) have further committed themselves to MTOs of at least -0.5% of GDP, unless the debt-to-GDP ratio is significantly below 60% and there are low risks for the sustainability of public finances.
The expenditure benchmark
As part of the 2011 reforms ("six-pack") to strengthen fiscal surveillance, the analysis of the MTO or the adjustment path towards it under the preventive arm of the SGP is judged by an assessment of the structural budget balance, complemented by an analysis of the growth rate of expenditure net of discretionary revenue measures. This requires that for countries at their MTO, any excess growth of new expenditure over a medium-term reference rate of potential GDP growth must be matched by discretionary revenue measures. Countries on their adjustment path must contain their net expenditure growth at a rate lower than medium-term potential GDP growth, again unless matched by discretionary revenue measures. This ensures a gradual strengthening of the underlying budget balance. The information to allow an assessment of these objectives is provided in the Member States' stability and convergence programmes (SCPs), which detail budgetary objectives and planned budgetary measures in accordance with fiscal policy guidelines as contained in the Treaty and the regulations.
Assessment of progress towards the MTO
As part of multilateral fiscal surveillance, the Commission conducts both an ex ante assessment for the current and forthcoming years and an ex post assessment for the previous year based on each Member State's stability or convergence programme. The ex ante assessment includes an examination of the medium-term budgetary objectives (MTOs) presented by Member States in their stability and convergence programmes, focusing on whether a) the MTO is appropriate, b) the country is at the MTO or if the adjustment path towards it is appropriate, considering the cyclical conditions and the sustainability risks, and c) the economic assumptions on which the programme is based are plausible. If the Council considers that the MTO or the adjustment path towards it presented in a stability or convergence programme is not appropriate, it will indicate in its country-specific recommendations that the Member State is invited to adjust its programme.
Additional step for euro area Member states
The Two Pack Regulation on common provisions for monitoring and assessing draft budgetary plans introduces an additional step in the ex ante monitoring of budgetary policies for euro area Member States. Specifically, the Two Pack establishes a common budgetary timeline for euro area Member States which requires these Member States to submit draft budgetary plans to the Commission by October 15 every year, prior to the adoption of the budget.
The Commission will provide two assessments:
This exercise mirrors the horizontal assessment of stability and convergence programmes taking place in Spring, but with a focus on the forthcoming year rather than on medium-term fiscal plans.
The Commission opinion on euro area Member States' plans will be based on the requirements of the SGP – in particular the country-specific recommendations issued under the preventive arm at the end of the European Semester and the need to comply with the MTO requirements.
For countries under an EDP, progress towards meeting the obligations stemming from the recommendations issued to the Member State will be a central aspect of the assessment. If the Commission identifies particularly serious non-compliance with the European budgetary policy obligations, it can ask for a new plan to be submitted.
In the ex post assessment, the Commission determines whether a Member State has made sufficient progress towards the medium-term budgetary objective (MTO) compared to the benchmark of an annual improvement of the structural balance equal to 0.5% of GDP. This assessment is further on compliance with the expenditure benchmark. If the Commission finds evidence of significant deviation from the MTO or the adjustment path towards it—which is a conclusion based on an objective, numerical criteria—the Commission shall address a warning to the Member State concerned, which is followed by a Council recommendation within one month (see graph below). If not respected, this can be followed, in the case of euro area Member States, by a sanction equal to an interest-bearing deposit of 0.2% of GDP as a rule
Legal basis and steps under the preventive arm of the SGP (Reg. 1466/97):