Brussels to exempt defence spending from EU budget constraints

By Jan Strupczewski

BRUSSELS (Reuters) - The European Commission will propose exempting defence from EU limits on government spending, the head of the EU executive, Ursula von der Leyen, said on Friday, amid pressure from U.S. President Donald Trump for Europe to finance its own defence.

The U.S. wants European members of NATO to more than double military expenditure to prepare for a potential Russian attack, rather than counting on help from Washington, because the U.S. is now more focused on threats from China.

Von der Leyen said the lifting of restrictions on defence spending would follow the same logic as the removal of borrowing limits during the COVID-19 pandemic.

"I believe we are now in another period of crisis which warrants a similar approach. This is why I can announce that I will propose to activate the escape clause for defence investments," she said in a speech at the Munich Security Conference.

"This will allow member states to substantially increase their defence expenditure. Of course, we will do this in a controlled and conditional way."

European Union debt and spending rules, revised only last year, exist to protect the value of the euro currency by preventing excessive government borrowing.

They set an annual net spending limit for governments to make sure that, over four to seven years, their public debt starts to fall.

But if there are exceptional circumstances outside a country's control that could substantially affect public finances - like the threat of a Russian attack - the Commission can activate a one-year "escape clause" for that country. This can also be extended, one year at a time.

EU DEFENCE SPENDING LENIENCY LIKELY TO BE CONTROVERSIAL

The Commission could also activate a general escape clause for the whole EU, although the rules allow this only in the event of a severe economic downturn in either the euro zone or the EU as a whole.

It was not clear which option von der Leyen had in mind.

The Commission would need the agreement of other governments to activate any escape clauses. Some are concerned it could trigger a negative market reaction.

"By activating the general escape clause to boost defence spending, the Commission is playing with fire," German Member of the European Parliament Markus Ferber said.

"Many Member States are already highly indebted and in the end markets will only ask if debts can be repaid, not if they were used to finance tanks or social expenditure."

Highly indebted Italy not only welcomed the Commission's announcement but saw it as a stepping stone to more joint financing - anathema to the more "frugal" northwest European EU members such as Germany and the Netherlands.

"This is a first, fundamental step in the right direction, which must also be followed by the establishment of common financial instruments," Italian Prime Minister Giorgia Meloni said.

Senior EU government finance ministry officials are now discussing what comes under "defence spending" as the existing definition is narrow and mainly comprises already delivered hardware such as tanks or fighter jets.

Ammunition factories, civilian bomb shelters or bridges strong enough to support tanks are currently seen as construction, rather than defence. An agreement on a new definition would therefore also have consequences for public finances.

"If the Commission activates the escape clause, the exemption has to be specific and narrow. Otherwise we will be surprised what Member States start labelling as defence spending," Ferber said.

(Additional reporting by Alvise Armellini in Rome; Reporting by Jan Strupczewski; Editing by Kevin Liffey)