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Tuesday, 12 February, 2002, 12:17 GMT
Analysis: Europe's budget 'stitch-up'
A carnival parade in Germany
Does Germany risk making the euro a laughing stock?
By BBC News Online's James Arnold

You could hear the groans all over Europe.

EU budgets, % of 2001 GDP
Germany: -2.6
Portugal: -2.2
France: -1.4
Italy: -1.1
UK: -0.6*
Spain: 0
Ireland: +1.4
* Based on 2001-02 fiscal year
The news that EU finance ministers had opted not to punish Germany and Portugal for budgetary sloppiness has reinforced the notion that Europe will always put political expediency ahead of economic good sense.

Two weeks ago, the European Commission voted to issue a formal warning to the two countries, whose budget deficits were wobbling dangerously close to eurozone limits.

The fact that ministers stitched up a face-saving compromise has risked controversy.

But does it also risk an economic headache?

Pointless Pact...

The Stability and Growth Pact is now in effect a dead letter.

The rules, stipulating a warning when a state approaches its budget deficit ceiling, are clear and unambiguous.

German Finance Minister Hans Eichel
German Finance Minister Hans Eichel is thinking of the voters back home
On this, their first public test, they have been brutally steamrollered.

This is certainly embarrassing, for several reasons.

First, it was the Germans who insisted on tough eurozone budgetary rules - known as the Stability and Growth Pact - in the first place.

Five years ago, Germany was concerned that potential budget renegades, such as Italy, needed shackling, if faith in the single currency was to be maintained.

Now Germany, along with Portugal, has become the first country to break its own rules.

... powered by politics

Second, any form of political interference in economic issues looks desperately bad in the eyes of the money markets, which have ruthlessly driven the euro down since its introduction three years ago.

The EU is keen to prove that it can create independent, objective institutions, but time and again its bigger members - especially Germany - treat it as a fiefdom.

It is election year in both Germany and Portugal, a time when governments do not want to be seen as in being thrall to Brussels.

One of the main factors behind the weakness of the euro is the perception that the interests of voters in Leipzig or Lisbon are not in line with economic good sense.

This week's deal implies that the voters will always win out in the end.

Good riddance?

Just how serious a problem this poses is far from clear.

UK Chancellor Gordon Brown
Gordon Brown worries what might happen if Britain joined
Germany argues that it was scarcely in line for a drubbing in any case: it had committed the least severe infringement under the Pact, and was only due for a mild warning, rather than any outright punishment.

Both countries have promised to be on their best behaviour, an agreement that EU officials are already trumpeting as a triumph.

In any case, many economists say the Pact was a poor rule, since variations in country deficits could be dealt with by the markets - by marking down the debt of delinquent countries - better than by governments.

And some sort of flexibility would have been called for sooner or later anyway, in order to accomodate new euro members whose economies diverge from the current norms.

Significantly, the UK was one of the countries lobbying for leniency, fearing perhaps that it would need similarly understanding treatment if it joined the eurozone.

Wanted: discipline

But it is too straightforward just to say "good riddance" to the Pact.

The current arrangements may not work, but the majority of economists feel that Europe needs some form of long-term fiscal mechanism.

Although Germany is predicted to have a deficit of 2.7% of gross domestic product (GDP) this year, neatly below the Pact's 3% ceiling, some are already warning that it could shoot much higher.

The German government is keen to spend, egged on by the opposition and the country's 4 million-plus unemployed.

In the longer term, governments around the region will need to boost expenditure in order to grapple with the three challenges of mounting state debt, ballooning pension liabilities and subsidy-craving new EU members.

Investors nervously holding Europe's single currency face uncertainty enough in the near future.

Pesky politics just adds another level of risk.

See also:

12 Feb 02 | Business
Germany escapes EU wrath
30 Jan 02 | Business
Q&A: EU budget warnings
30 Jan 02 | Business
EU raps Berlin and Lisbon on budgets
07 Feb 02 | Business
Duisenberg to quit ECB
21 Jan 02 | Business
Budget worries at euro talks
04 Dec 01 | Business
EU eyes German budget deficit
11 Feb 02 | Business
Storm looms at EU meeting
22 Nov 01 | Business
Rich countries on the brink
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