By Paul Hannon


The European Union's budget watchdog Wednesday criticized a move to exempt government spending on reducing the use of fossil fuels from the bloc's budget rules, saying it opens the way to a repeat of overspending following Russia's 2022 invasion of Ukraine.

The jump in prices of oil and natural gas since the conflict in the Middle East began in late February has highlighted the downsides of Europe's reliance on imported energy, with the bloc's economy set to slow in response to the increase in costs.

The European Commission last week proposed that government spending designed to strengthen the bloc's energy security by increasing the use of alternatives to fossil fuels should be treated in the same way as defense spending, and exempt from its budget rules.

In a report Wednesday, the European Fiscal Board said that exemption could be misused by European governments, and open the way to a big increase in spending to support households and businesses that would repeat earlier mistakes.

"Fiscal credibility, built through adherence to agreed expenditure paths, is our best protection against rising borrowing costs," said Pieter Hasekamp, chair of the EFB. "Support for households and businesses must be temporary, targeted, and offset - not a backdoor to broader loosening."

European governments have been criticized by the International Monetary Fund and other economists for offering too much support to households and businesses that didn't need it during the 2022 shock, thereby needlessly fueling inflation and raising already high levels of government debt.

European Central Bank President Christine Lagarde has warned governments that policymakers might have to raise their key interest rate more than would otherwise be the case if they are too generous with their support for households facing higher energy costs.

The Commission expects that the combined deficit of the eurozone's 21 members will rise to 3.5% of their gross domestic product next year from 3.3% this year, while outstanding debt is projected to rise to 91.2% of GDP from 90.2%. By comparison, the Congressional Budget Office expects the U.S. government's deficit to be 5.8% of GDP in this fiscal year, and 5.7% in 2027.

European governments have again provided some support for households and businesses as energy prices have surged since the start of the conflict. However, those measures have been more modest in scope than during the previous energy shock, with the EFB estimating that they amount to less than 0.1% of eurozone GDP.

"For now, these measures are designed to be short-lived in 2026 and comparatively modest," Hasekamp said.

Some economists see the Commission's decision to exempt some energy spending as having little impact on government borrowing. The exemption only allows governments to request exemptions totaling 0.3% of GDP in any single year from 2026 to 2028, but with a total limit of 0.6% over that period.

Moreover, that spending would be counted within the existing exemption for defense spending, which is 1.5% of GDP.

"The expansion is limited to a specific category of expenditure tied to reducing dependence on fossil fuels," economists at Morgan Stanley wrote in a note to clients. "To date, such spending has been relatively underrepresented in the commitments made by member states, where meaningful spending has taken place at all."


Write to Paul Hannon at paul.hannon@wsj.com


(END) Dow Jones Newswires

06-10-26 0814ET