Euro zone budget rules unravel

Posted in Europe | 08-Dec-03 | Author: Thomas Fuller| Source: International Herald Tribune

BRUSSELS - In a bitter clash between the referee and the two most powerful players of the euro zone, the referee lost Tuesday: France and Germany, the Continent's economic titans, steamrolled over objections by the European Union's head office and won the backing of a majority of countries to suspend the rules that govern the shared currency - rules that Paris and Berlin are violating.

The European Commission, the referee, called the vote illegal and hinted that it might take court action.

"We have changed from a rule-based system to a political-based system," said Pedro Solbes, the European commissioner overseeing budget issues. "This is a very serious change."

In a public scene rarely witnessed in Brussels, Solbes openly clashed at a news conference on Tuesday with the Italian chairman of the finance minister's council, who sought to defend the suspension of the rules.

Solbes was backed by the European Central Bank, which issued, in 11 languages, an extraordinary rebuke of the decision, saying it carried "serious dangers."

"The failure to go along with the rules and procedures foreseen in the Stability and Growth Pact risks undermining the credibility of the institutional framework and the confidence in sound public finances of member states across the euro area," the bank's governing council said, referring to the agreement that limits member deficits.

By the reserved standards of central bankers, it was perhaps the most emphatic statement of concern since euro notes and coins were introduced two years ago. The bank said governments should "live up to their responsibilities." It urged France and Germany to curb their excessive spending, implying that the open squabbling over budget deficits had "negative effects on confidence."

Solbes was at a loss for words when asked what would happen to the system of budgetary oversight - a key feature of Europe's euro experiment - now that the euro member countries had decided to derail the procedures that he is charged with managing.

"This is a serious change," he said. "It's very difficult to assess."

The European Commission had sought disciplinary action against France and Germany if the two did not make tangible efforts to reduce their budget deficits, both of which were forecast to come in above the legal limit in 2004 for the third straight year.

But after a majority of euro-zone finance ministers attending the two-day meeting rejected the commission's recommendations, the Italian finance minister, Giulio Tremonti, who is the current chairman of the council, helped cobble together a significantly softer set of spending cutbacks for Berlin and Paris.

Instead of asking France to cut its deficit by E6 billion, or $7.1 billion, more than already foreseen in its 2004 budgets - as demanded by the commission - the council recommended Paris cut by only E1 billion. In the case of Germany, for which the commission recommended E5 billion to E6 billion in additional cuts, the council requested no additional cuts.

Significantly, the council also agreed to hold what is known as the excessive deficit procedure for Germany "in abeyance for the time being." A statement with the same wording was also issued for France.

This effectively suspended the procedure that forces countries to cut their deficits or face hefty fines. Ironically, it was Germany that had insisted on this strict fiscal discipline when the Stability and Growth Pact was adopted in 1997.

The vote in the early hours Tuesday was 7 for and 4 against, with France and Germany not permitted to vote on matters involving themselves.

Analysts speculated that there were various political motives among the countries that supported Germany and France, ranging from the personal ambitions of their leaders to negotiations for the future European Constitution.

Austria, Finland, the Netherlands and Spain, which had hotly rejected the proposal, warned Tuesday of the consequences. News agencies quoted Prime Minister José María Aznar of Spain calling it "not a good day for Europe" while Chancellor Wolfgang Schüssel of Austria described the decision as a "sin."

Dutch Finance Minister, Gerrit Zalm, said: "The pact is not dead, but it's in the refrigerator." Francis Mer, the French finance minister, rejected criticism by the European Commission.

"The spirit of our institutions were respected," he said at a news conference. "The commission does not have a monopoly on thought," Mer said.

Asked specifically about criticism that procedures had been abandoned, Mer said that ministers had voted six times during the course of the night. "If that's not a legal basis, what is law?" he asked testily.

But analysts had a different view. They said Tuesday's move could weaken the currency, which in recent months has done the opposite, appreciating sharply against the dollar.

"The split between bigger countries on one side and some smaller countries and the EU Commission on the other is potentially dangerous for the future of European integration," said Lorenzo Codogno, a European economics analyst at Bank of America.

"The market reaction has been muted, but the outcome should be perceived as a long-term negative for the euro and euro denominated assets."

Graham Watson, the leader of the Liberal Democrat faction in the European Parliament, said: "Citizens may well ask what is the point of agreeing new rules to run the European Union if the big countries will ride roughshod over them when the going gets tough."

Mer, the French finance minister, said he had the support of the core members of the European Union. "If you look at how votes were cast, you'll see that the heart of Europe - which is to say five of the six founders - were in agreement," he said.

He added that the pact needed to be "enriched" to better take into account periods of slow growth when, according to him, increased government spending is needed.

The calls for greater fiscal discipline come at an inconvenient time for Paris and Berlin. The French and German governments are both trying to push through stimulus packages including tax reductions.

Germany's finance minister, Hans Eichel, said the decision Tuesday was "difficult" but "realistic."

"The pact is alive," Eichel said. "The only appropriate question today is how to emerge from weak growth in Europe."