The European Union member states have agreed on two fundamental budget rules. A member state's national debt must not exceed 60 percent of its GDP, and the budget deficit must not be greater than 3 percent of GDP. In the case of the latter, Estonia is on the threshold.

Last year, Estonia's deficit was 3.4 percent; this year, thanks to a negative supplementary budget, it is expected to be 3 percent, but this is not certain. Whether Estonia is violating the budget rules will be determined by the European Commission's report next Wednesday, June 19.

"The outcome of the report should be whether the Commission recommends initiating the excessive deficit procedure. The Commission will consider various factors that led to this deficit and decide whether it is justified to open the procedure or not," explained Ave Schank-Lukas, economic adviser at the European Commission's Estonian office.

In simpler terms, this means the Commission will provide Estonia with recommendations on how to balance the budget. Subsequently, in the fall, Estonia must submit a four-year plan to the Commission. In fact, all member states prepare this plan.

"For those countries that have no problems at all, this plan should show how they will maintain their current situation, and for other countries, it should outline the steps to achieve a sustainable budget position," Schank-Lukas said.

In other words, Estonia will not be fined initially, and no Brussels official will fly to Tallinn to draft the budget for the government. The Commission will first discuss with the member state how to get expenditures under control. How this will exactly look is still hard to say.

The new European Union rules only came into effect on April 30, so there are no practical examples yet of how they actually work.

"It's a bit like an experiment. Nothing like this has been done before. It is clear that the Commission cannot be too technical and do this automatically, so if a number is not in place, you immediately get fined. It doesn't work that way," said Edgars Eihmanis, a researcher in comparative politics at the Johan Skytte Institute of Political Studies at the University of Tartu.

Thus, the new rules should be significantly more flexible. This means, for example, that increased defense spending or support for the defense industry could be expenses that can be justified. It may be necessary to exceed the 3 percent limit for such expenditures.

"The Commission has hinted that they understand the need to spend on security, and they will not account for the increase in these costs. That would be a separate category," Eihmanis explained.

Eihmanis compared the new rules to the functioning of the recovery fund agreed upon at the beginning of the COVID-19 pandemic. "There was a big difference between what was written down and how it all actually worked. It's not that the practice contradicted the text, but there was a lot of room for interpretation."

However, Estonia is known for strictly adhering to the rules agreed upon in the European Union. In fact, Estonia could use this room for interpretation to justify a larger budget deficit if desired, said Eihmanis.

"Estonia could certainly argue that security concerns are important to Europe and the Commission right now. This could justify making investments that ensure Estonia's security and increase economic activity and productivity. For example, if the defense industry were to build factories for the production of armaments," said the researcher.

Estonia's budget deficit is just slightly below the European Union average of 3.5 percent of GDP.

"In the bigger picture, there are currently 11 member states not complying with this rule. Estonia is not in the worst position," noted Edgars Eihmanis.

The largest deficit is in Italy, at 7.4 percent, with Hungary, Romania and France also having significant deficits. Estonia's debt burden is among the lowest in the European Union, at just under 20 percent of GDP. In contrast, Greece's debt burden exceeds 160 percent of GDP, and 12 other member states have a debt burden higher than 60 percent. All these countries must now make plans to reduce their debt burden and budget deficit. If they fail, the Commission will have to impose increasingly stringent sanctions.

"The initial steps include recommendations to the country on how to get things under control. These recommendations are not public, but they can be made public. Another step is that a country's representative must go to the European Parliament to justify the situation. This is an uncomfortable position that no one wants to be in. Additionally, borrowing for the country could become significantly more expensive. For example, the European Central Bank could lower the country's rating," listed Schank-Lukas.

According to Schank-Lukas, there are several steps before fines are imposed.

"The idea with fines now is that they should be more reasonable in size so that they can be applied more automatically. Previously, it was a very political decision, and the fines were so large that in a bad situation, they would worsen the country's position so much that they were never actually applied. But yes, the final step is a fine," she said.

Under the new rules, a fine of up to 0.05 percent of GDP can be imposed on a country, which in Estonia's case would be around €19 million. Under the old rules, the fine could have been ten times larger. The Commission hopes that the new rules are flexible enough to be practically applied.

"Previously, there were fewer steps. There was the fine. The country knew that it was a very difficult political decision to apply it, and perhaps the motivation was not as great as the Commission's expectation with this new system," Schank-Lukas noted.

The Commission also hopes that if countries create their own plans on how to reduce expenditures, they will implement them.

"We hope this increases the country's sense of ownership, that this is my plan, I have foreseen these reforms and investments, and I have committed to getting these costs under control. This should also increase the motivation to follow through. It may also be easier to align it with the domestic budget process. In Estonia, we also have a four-year budget process. It should be quite possible to align it with this new four-year budget plan process," said Schank-Lukas.

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