The excessive imbalances procedure (EIP) Declan COSTELLO European Commission Directorate General for Economic and Financial Affairs DNB and IMF workshop on «Preventing macroeconomic imbalances in the euro area » Amsterdam, 13-14 October European Commission

Overall changes to economic governance Excessive Imbalances Procedure external and internal imbalances The Europe 2020 Strategy growth enhancing structural reforms European Systemic Risk Board financial stability and macro & micro level Stability and Growth Pact fiscal policy AND …. the ongoing debate on the EFSF and ESM as well as Eurogroup goverance

Broad scope of surveillance External positions (e.g. current accounts, net international investment positions) Competitiveness developments (e.g. REERs, ULCs) Export performance (e.g. export market shares) Private sector indebtedness (e.g. credit, debt) Public sector indebtedness Assets markets (e.g. housing) External imbalances Internal imbalances

Example of ‘test’ early warning scoreboard: Portugal 2001-2010   Threshold 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 EXTERNAL Current Account balance as a percent of GDP [+]/-4% -9,6 -9,7 -8,4 -7,7 -9,8 -10,4 -11,2 -11,1 Net IIP as % of GDP, BoP data -35% -47,6 -54,8 -56,7 -63,0 -67,6 -78,5 -88,2 -96,1 -109,0 -107,6 % Change (3 years) of Real Effective Exchange Rate (REER) with HIPC deflators +/-5% & +/-11% -0,3 2,3 9,6 8,1 5,3 1,4 1,5 2,7 1,3 -2,4 % change (5 years) in Export Market Shares -6% -6,2 1,6 -2,7 -2,9 -4,0 -5,6 -5,4 -13,1 -9,3 -8,5 ULC index (% change over 3 years) – thresholds 9% (EA) and 12% (non EA) +9% & +12% 11,1 12,0 11,4 8,3 8,6 5,5 5,7 6,0 8,7 5,4 INTERNAL % y-o-y change in House Prices +6%  1,9 -2,2 -1,9 -0,4 3,3 15,4 1,2 . Private sector Credit flow as percent of GDP 15% 22,5 12,7 9,8 10,7 14,5 17,2 24,9 21,0 7,1 3,0 Private sector debt as percent of GDP 160% 187 192 197 198 206 215 229 245 252 248 Public sector debt as percent of GDP 60% 51 54 55 56 62 64 63 65 76 83

The preventive arm of the EIP Policy response No problem Procedure stops. Alert mechanism Economic reading of early warning scoreboard indicators to identify Member States with potential risks In-depth review Analysis to distinguish between benign and harmful macroeconomic developments and to identify policy options Imbalance exists Commission/Council recommendations under Article 121.2 Severe imbalance Commission/Council recommendation under Article 121.4

The Corrective Arm Sufficient abeyance Member State is placed in “Excessive Imbalance Position” Corrective Action Plan Surveillance of compliance with reform commitments Insufficient fine 0.1% of GDP Insufficient: interest bearing deposit Insufficient: Fine 0.1% of GDP

The Corrective Arm is INTRUSIVE and FOCUSSED Sufficient abeyance Member State is placed in an Excessive Imbalance Position Corrective Action Plan Surveillance of compliance with reform commitments Fine 0.1% of GDP Insufficient: interest bearing deposit Insufficient: Fine 0.1% of GDP

… and works by reverse Qualified Majority Voting Sufficient abeyance Member State is placed in an Excessive Imbalance Position Corrective Action Plan Surveillance of compliance with reform commitments Fine 0.1% of GDP Insufficient: interest bearing deposit Insufficient: Fine 0.1% of GDP

Challenges in applying the EIP Analytical large degree of qualitative judgement especially if acting early requires considerable country specific knowledge; data limitations limited consensus on policy responses. Political greater awareness of the costs of inaction and spillover effects; not easy to form blocking minorities; macro challenges with euro area spillovers that require micro policy responses in areas of national competence … hinge on effective governance reforms of the Euro area

Additional slides

How the EIP fits into the European semester (indicative based on timing of 1st year)

Formal links between the EIP and ESRB in the draft legsialtion Commission recommendation – in depth studies "any early warnings or recommendations from the ESRB relevant to the Member States under review" into account European Parliament has proposed additional cross references choice of indciators in the scoreboard alert mechanism report

Exploring the interlinkages between the EIP and ESRB Scope of surveillance External imbalances, competitiveness, internal imbalances -macro-prudential oversight of the financial system Nature/approach of surveillance Prevention/correction of unsustainable macroeconomic imbalances Country specific Systemic risks to the financial system Thematic Monitoring and enforcement Annual exercise linked to European semester Legal policy recommendations can be addressed to Member States Scope for financial sanctions on euro area Member States Continuous process of surveillance Possibility to address non-legally binding warnings and recommendations to Member States, EU institutions, national/EU supervisory authorities – which can be made public This table gives a simple comparative perspective of ESRB’s surveillance and Commission’s surveillance under the EIP. In terms of scope of surveillance, there are certainly interlinkages between the two. While performing macro-prudential oversight of the financial system, ESRB will have to take into account macroeconomic imbalances. Under the EIP, the Commission will have to take into account how financial risks could contribute to macroeconomic imbalances. At the time when the legal basis of the ESRB have been established, the interactions with the EIP could not be considered since the EIP did not yet exist. The EIP draft regulation attempted to shed some light on the interactions, and therefore in its draft article 5 it is mentioned that “any early warning or recommendations from the ESRB relevant to the Member State under review” shall be taken into account under the EIP. The following scenarios could be envisaged: When ESRB issues warnings and recommendations that become at a later stage relevant to the built up of macroeconomic imbalances, the Commission may use these as an input in its preventive arm. In a second stage, ESRB’s warnings and recommendations can be supported by a legal follow up in the corrective arm of the EIP where sanctions can be used. The Commission decides that potentially harmful imbalances may build up in a MS, which may however do not seem to be linked to macro-prudential issues (e.g. competitiveness issues). In this case the ESRB will not intervene. The Commission launches an in-depth review and the ESRB issues recommendations when a Member State’s situation signals macroeconomic imbalances and risks to the macro-financial stability. In this case, timely cooperation between the Commission and ESRB will be the most important. Relations between the two institutions are ensured: Via a member of the Commission participating with voting rights in the Steering board of the ESRB Via the EFC, which channels all ESRB warnings and recommendations to the Council At a technical level The Commission provides the ESRB with quarterly analyses covering macroeconomic imbalances as well. It would be useful if ESRB offers the Commission: Analyses of the resilience of the financial system with respect to the risks of identified macroeconomic imbalances and possible amplification mechanisms; Analyses of possible contagion or spillover effects to other countries through different components of the financial system; Advice regarding possible macro-prudential policy measures to address macro-economic imbalances with systemic risk implications.

Ensuring synergies Commission-ESRB: ECFIN Commissioner is permanent member with voting rights on ESRB Steering Board and provides inputs ECOFIN-EFC-ESRB: Council can be a recipient of ESRB recommendations or warnings and EFC President is a non-voting member of ESRB EIP-ESRB-Parliament: ESRB required to present annual report to Parliament and there will be regular meetings with ECON Committee. Parliament is co-legislator for EIP and will be involved at various steps of the procedure Cooperation at technical level between Commission, ESRB and ECB

Scope of surveillance under the EIP External imbalances current account balance net international investment position change in REERs change in nominal ULC change in export market shares Internal imbalances Private sector credit flow Private sector debt Change in house prices General government sector debt [financial/banking sector]