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Explainer-Why Germany doesn't like the EU's debt reform proposals

FILE PHOTO: A woman wearing a protective mask walks past the skyline of the financial district during sunset as the spread of the coronavirus disease (COVID-19) continues in Frankfurt

BERLIN (Reuters) - EU finance ministers started talks last week on adjusting the bloc's fiscal rules to the post-pandemic realities of high debt and significant investment needs, but some countries are not happy with the first proposal, particularly Germany.

WHICH RULES WILL BE REFORMED?

The EU is discussing how to adjust rules that govern national budgets, known as the Stability and Growth Pact. According to the Maastricht Treaty, a country's budget deficit should not exceed 3% of gross domestic product and the overall government debt should not exceed 60% of GDP.

The rules will remain suspended until the end of the year after first being paused in 2020 in response to the COVID-19 pandemic.

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WHY DO THEY NEED TO BE REFORMED?

If a government does not respect these rules, it can be fined, but this has never happened and is unlikely to. Most countries were not complying with the rules before they were suspended in 2020.

Some countries argue that these rules are not realistic, particularly in the post-pandemic reality of high public debt and moves towards a zero-emissions economy against the backdrop of a cost-of-living crisis.

WHAT IS THE EU PROPOSING?

The EU Commission has proposed individual debt reduction paths. This means that the Commission would negotiate with a plan to reduce debt with each individual country. Instead of implementing one-size-fits-all rules, the Commission will take a more flexible approach, taking into account the current and future conditions of each country to find a feasible path towards the debt reduction goals.

The Commission proposed that countries would have four years to put debt on a robust downward path through an appropriate setting of net primary expenditure every year. This would ease the burden of quick adjustment on countries like Italy, which has a public debt of 148% of GDP, or Greece with 186%. The four years could be extended to seven if justified by investment in areas that are a priority for the EU, like fighting climate change, or reforms that improve debt sustainability.

WHY DOES GERMANY REJECT THIS PROPOSAL?

German Finance Minister Christian Lindner is in favour of a "multilateral rules-based approach." Germany is critical of bilateral negotiations between the European Commission and individual countries, arguing that tailored rules will mean that not all countries are equal. Germany wants clear rules, with numerical references and benchmarks, applicable to all countries so that comparisons are feasible.

The second argument is that longer and individually negotiated debt reduction paths would encourage governments to postpone difficult decisions to near the end of the timeframe. For Lindner, it is essential that deficits and debt ratios are reduced at the same time in every adjustment phase.

DOES GERMANY HAVE ANY ALLIES?

Countries such as Denmark and the Netherlands consider poorer southern countries to lack fiscal discipline. Last week, as negotiations for the reforms started, the German finance minister visited Finland and Austria, countries with a similar stance on fiscal rules.

IS THERE ROOM FOR COMPROMISE?

"Germany recognises that some member states need slightly more flexible adjustment paths in terms of time," Lindner told Reuters, adding that monitoring of the rules should become more binding.

For countries with public debt higher than 60% of GDP, the rules stipulate that debt should be reduced by 1/20th of the excess, as an average over three years.

"It doesn't do us any good if we have very ambitious timeframes, but in reality we arrive at ever higher debt levels," Lindner told Reuters.

WHAT DOES THIS MEAN FOR FINANCIAL MARKETS?

Anything perceived as strengthening the euro zone's infrastructure and favouring cohesion is welcomed by financial markets, as was the case with the Next Generation EU pandemic response fund. The debt reform would likely strengthen the euro and narrow government bond yield spreads over Germany. Once agreements are reached, the reform of the Stability and Growth Pact to adapt to post-pandemic realities could help avoid fragmentation within the bloc.

(Reporting by Maria Martinez, Editing by Friederike Heine and Susan Fenton)