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The economic crisis has taken a heavy toll on EU Member States' public finances, making debt sustainability a major challenge across the Union.

At the same time, a major overhaul of EU fiscal surveillance is underway.

The 2011 Report on the Public Finances in EMU takes a look at the recent developments in public finances, analyses new ways of assessing debt sustainability and describes the changes to budgetary surveillance in the EU. These reforms put prevention and debt reduction at the centre of EU budgetary surveillance, reflecting on the lessons of the crisis.

"In a period of high and still increasing debt levels in EU countries, ensuring the sustainability of public finances is a prerequisite for enduring economic growth and job creation. The EU strategy of gradual, differentiated fiscal consolidation remains valid in the face of persistent market turbulence and uncertainty about the speed of recovery.

The Member States facing market pressures must continue to deliver on reaching their fiscal targets, and take additional measures if needed. Member States with fiscal room of manoeuvre should allow automatic stabilisers to function to mitigate the effects of a slowdown of the recovery on activity and jobs while sticking to their structural adjustment paths.

The recent developments underline the importance of adopting very soon the legislative package to reinforce our economic governance", said Economic and Monetary Affairs Commissioner, Olli Rehn.

While a process of consolidation is underway in the EU, the debt to GDP ratio is continuing to rise and is set to reach 83.3% of GDP in 2012 – an increase of over 20 points of GDP from its level of 2007.

The consolidation measures that have been introduced are addressing this rising level, and the Member States have indicated plans to intensify these in their Stability and Convergence Programmes.

Following through on these plans would lead to debt stabilising by 2012; the challenge is therefore to ensure that these more ambitious plans are indeed put into practice while preserving appropriate differentiation across Member States in accordance with available fiscal space.

The second part of the report presents the EU response to the lessons of the fiscal crisis, the legislative package that contains six pieces, of which four relate to budgetary policy.

The reform will introduce an expenditure rule into the preventive arm of the Pact, and will make the debt criterion operational in the corrective arm, while introducing sanctions to the preventive arm for the first and intensifying those in the corrective arm.

The third part of the report illustrates the link between budgetary frameworks and sovereign spreads. It shows the impact of fiscal governance procedures on markets' perception of countries' sustainability risk.

The results confirm the idea that alongside the level of the deficit and debt, a higher quality of fiscal rules is linked with a lower yield spread. Countries with the highest deficits and debt have the most to gain from an improvement in their fiscal governance in terms of a reduction in their spreads.

Finally, the report shows the importance of macro-financial financial imbalances in fiscal vulnerabilities and the relevance of regulatory reforms in the banking sector to reduce threats.

The analysis also shows that EU countries are currently making historically large fiscal consolidation efforts, and assesses the cost in terms of future GDP of consolidating public finances via increased taxation.

The Report is available on:
http://ec.europa.eu/economy_finance/articles/eu_economic_situation/2011-09-pfr-2011_en.htm