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French and German officials are already in contact over a new regime for limiting eurozone public borrowing as Berlin relaxes its historic affinity for balanced budgets and even indicates it might consider making some Covid fiscal support permanent if the current measures prove successful and in return for strong rules on oversight, sources in Brussels told MNI.

Eurozone-wide talks on the Stability and Growth Pact are only expected to get underway in September, so news of Franco-German contact will raise hopes the EU's two biggest countries could drive reform forward despite likely divisions between fiscal hawks and doves within the Commission and among member states.

"German and French officials are already in contact at sub-ministerial level," a source close to the discussions said. "There's a certain willingness to regenerate that discussion."

A new German readiness to embrace reform of SGP has been key to a closer understanding on the direction for reform of fiscal surveillance, the source said. While the pact has been suspended during the Covid pandemic, some countries have called for a permanent loosening of fiscal restrictions.

TONE CHANGES

"The tone has changed. Germany has become more open since (former German Finance Minister Wolfgang) Schaeuble left," the official said.

"Germany is having a debate also on its suspended debt brake – 'when should we reintroduce it?', 'Is it going to be too tough for the coming environment?'"

The success of the EU's Covid fund, the EUR672.5 billion Recovery and Resilience Facility, will be key to progress on new fiscal rules, the official said.

"The better the RRF goes the more chance there is this becomes a permanent stabilisation function. But there would have to be something in return for common funding, in terms of common surveillance," the source added.

This will be crucial to any fiscal bargain between fiscal hawks and doves. Clinching agreement will also be complicated by looming elections in both Germany and France.

Speaking at a briefing, EU Budget Commissioner Johannes Hahn also indicated on Wednesday that should the RRF prove a success it could lead to permanent EU-level fiscal support measures.

NUMERIC TARGETS

Sources say the Stability and Growth Pact's numerical targets, including limits of 3% of GDP for budget deficits and 60% for government debt, may be modified but are unlikely to be wholly abandoned and that there is no appetite for the proposal by former IMF Chief Economist Olivier Blanchard for purely qualitative benchmarks.

"An arbitrary rule is better than nothing at all," the source said.

Nevertheless, there will be a greater role for 'discretion' in EU fiscal surveillance, although not the much-criticised bilateral discretion which the EU Commission has shown towards Italy in particular in the recent past.

"It has to be discretion supported by analysis and understanding," the source said.

"So numerical rules, but working more slowly, with more revisions and a greater focus on cyclical and sustainability issues."

Germany's willingness to consider a new approach has been improved by French progress on structural reform under President Emmanuel Macron, the source said. The arrival on the scene of Italian Prime Minister Mario Draghi could add further political momentum for reform, although the elections in Germany in September and in France in 2022 may narrow the window during which he might play an important mediating role.