+44 (0)20 7799 6677

The Fiscal Stability Treaty (Fiscal Compact)

PDF version

The Fiscal Stability Treaty (2012), also known as the Fiscal Compact, is an intergovernmental treaty introduced by a number of countries in the European Union to strengthen rules aimed at reducing government debt. The treaty was introduced following the financial crisis, during which governments’ high levels of borrowing were exposed, and a number of countries found they were unable to keep paying their debts. The idea is that by reducing the level of borrowing and debt, countries will be in a better situation to deal with future financial crises.

The introduction of the single currency, the euro, was an important step towards Economic and Monetary Union in the European Union. In 1997, the EU Stability and Growth Pact was agreed to try to ensure that members of the single market, and particularly the eurozone, had a manageable level of debt to protect the stability of the single market and the euro currency. The 2008 financial crisis and the following recessions made it clear that governments across the EU still had high levels of debt which hampered their ability to restore stability to the single market following economic crises.

By 2010, Greece was no longer able to pay its debts and requested bailout funds. There were also a number of other eurozone countries in financial trouble and other bailouts soon followed for Ireland, Portugal and Spain. The increasing debt levels of eurozone members led to questions being asked about why no action had been taken earlier to prevent this and why more rigid rules were not in place to prevent difficult financial situations arising in the first place.

In December 2011, under mounting international pressure, an EU summit was called to try and resolve the eurozone crisis and restore calm to the markets. The all-night session resulted in the blueprint for the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union, the official name of the Fiscal Stability Treaty. It was designed to build on the Stability and Growth Pact which had failed to protect against the eurozone crisis.

Initially designed to be a new EU treaty, the refusal of two member states – the UK, after failing to secure safeguards for the UK’s financial services sector, and the Czech Republic – to sign the agreement meant the treaty had to be modified. On 2 March 2012, 25 EU leaders signed it as an intergovernmental agreement.

The treaty did not require unanimous ratification to enter into force – instead it needed to be ratified by 12 of the 17 eurozone countries to enter into law. The treaty came into force in January 2013. Since then, 25 EU member states have ratified the treaty with only the UK, the Czech Republic and Croatia not signed up to any provisions under the treaty.

Key Treaty Provisions

As well as outline budget limits to prevent member states’ debt from getting more out of control by enforcing good fiscal discipline, the treaty allows for central oversight powers to enforce the rules and heavily fine countries that break them. Key rules include:

  • Debt brake: if a member state’s debt is greater than 60% of its GDP it must be reduced by a certain percentage every year.
  • Balanced budget requirement: meaning all member states party to the treaty must make sure their budgets are balanced, with little or no borrowing, or in surplus.
  • An Automatic Correction Mechanism: designed to correct any deviation from the limits put in place by the treaty.

Legal Details

The rules of the Fiscal Stability Treaty must be written into domestic law in signatory member states. Although the Fiscal Stability Treaty is an intergovernmental treaty, it operates as an extension of the EU Stability and Growth Pact and is managed by EU institutions. If signatory countries fail to follow rules set out in the treaty, they can be referred to the European Court of Justice by the Commission. The court has the power to impose an annual fine of up to 0.1% of a member state’s GDP if it does not comply with its ruling.