Analysis: Italy and France win debt rule change

Indebted governments have persuaded eurozone authorities to back down over penalties for breaching state debt rules, a ­problem at the heart of the eurozone crisis.

Eurozone authorities were planning to penalise member states automatically if their budget deficits exceeded 3% of GDP or if total government debt rose above 60%.

However, France and Italy, both of which are in breach of the rules, persuaded them to put the penalties to a vote in each case, buying time and potentially sympathy for the states involved.

Critics of the French and Italian proposals say the eurozone did not provide sufficient incentives for countries to stick to its deficit rules and avoid the government debt ­crisis of the past year.

But others dismiss the deficit rules as impractical for some countries, given the amount of government stimulus required during the financial crisis. (article continues below)

Azad Zangana, a European economist at Schroders, points out that fines would be particularly ­counter-productive in a case such as Italy’s.

“Italy has generally been very good at managing its deficit,” he says.

According to Zangana, Italy is trying to reduce its large public debt burden by running annual budget surpluses and avoiding ­fiscal stimulus, despite the crisis. The country runs low debt levels outside the public sector, Zangana says, and the economy argu­ably needs a higher public debt level to compensate.

The deficit rules also fail to take account of individual national circumstances such as how budget deficits are financed.

Deficits financed locally are generally more sustainable than those financed internationally, as invest­ors generally have a bias towards their local markets.

One of Greece’s key problems during its bail-out by the eurozone was that a large proportion of its debt was financed by overseas creditors, some of whom were also taking a currency risk by investing in euro-denominated debt.

Japan, for instance, has one of the largest public debt burdens in the developed world as a proportion of its GDP. However, the burden has generally proved easy to finance because more than 90% of the debt is owned by domestic investors seeking low-risk exposure to the local currency.