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Wednesday, 30 January, 2002, 11:02 GMT
Q&A: EU budget warnings

The European Commission has voted to issue Germany and Portugal with warnings over their swelling budget deficits. What does this mean and what are the likely consequences? BBC News Online explains.

What is a budget deficit and why does Germany have one?

A budget deficit is a measure of how much government spending exceeds its revenues, usually expressed as a percentage of gross domestic product (GDP).

In recent years the UK and the US have usually run budget surpluses.

But most rich countries prefer to run a modest deficit.

Just as perfectly well-off people habitually carry a little short-term debt that they could easily afford to pay off, so countries use deficits as a handy way to smooth cash flow.

But such sensible housekeeping can quickly start to run out of control.

In recent years, as the once-mighty German economy has slowed, the government has had to hike net spending - at least in proportion to GDP - in order to safeguard quality of life, despite falling tax revenues.

Its deficit was 2.6% of GDP last year, compared with a forecast of 1.5%.

How has the EU become involved?

As a consequence of the Maastricht Treaty, members of the eurozone have to keep their policies pretty much in line with each other.

As regards budgets, the EU's so-called Stability and Growth Pact says that no eurozone state can have a deficit of more than 3% of GDP.

Furthermore, the 1997 Pact obliges Europe's Council of Ministers to warn any country that is coming close to breaching its guidelines, and even make recommendations on how policy could be changed.

At bottom, the EU is concerned that the stability of the single currency should not be endangered.

If member states have wildly diverging economic policies, Brussels will scarcely be able to demonstrate that the euro is a sensibly and predictably maintained currency.

Does Brussels have teeth?

Not very sharp ones.

Wednesday's announcement from the Commission is just the first step towards a warning from the Council of Ministers.

Thereafter, Brussels does in theory have the weaponry to punish straying states, but takes a long time to deploy it.

Last year, it condemned Ireland for departing from fiscal rigour, but did not punish it.

This warning is a little different, since it is the first specifically under the terms of the Stability and Growth Pact.

But the notion that it will quickly get around to fining these countries, or even criticising them in particularly harsh terms, simply does not seems plausible.

This all sounds rather abstruse. Why has it got so much press?

The overt explanation is that the performance of Germany, by far the eurozone's biggest economy, is particularly crucial to the future of the euro.

Ireland, Portugal and so on can misbehave as much as they like, but the overall effect on Europe's financial system would be minimal.

This episode has been particularly closely watched since it is the first big test of the Stability and Growth Pact, a document that was the cause of some inter-governmental strife last year.

In fact, there is a great dose of Schadenfreude in the current press coverage.

Many - especially in the UK - are gleeful that Germany seems to be in difficulty, and are keen to point up the strains inherent within the eurozone.

Added irony springs from the fact that Germany was the country that insisted on the Stability and Growth Pact rules in the first place, in order to balance the perceived fiscal incompetence of Italy.

It is election year in both countries. Should political fall-out be expected?

Yes, but not necessarily of the obvious sort.

The media tend to portray deficits as bad news, and the Commission is certainly unhappy.

But the German and Portuguese public are unlikely to be of the same opinion, preferring well-funded public services to fiscal rectitude.

Maintaining government spending despite the economic downturn is certain to be a crowd-pleasing measure at home.

In Germany, opposition leader Edmund Stoiber has said he will boost spending further, up to the 3% ceiling.

These views may be modified, if the downturn persists and taxes have to be raised, or at least tax cuts are postponed.

But by that time, the elections will be safely in the past.

See also:

30 Jan 02 | Business
EU raps Berlin and Lisbon on budgets
21 Jan 02 | Business
Budget worries at euro talks
04 Dec 01 | Business
EU eyes German budget deficit
30 Nov 01 | Business
France and Germany lose jobs
21 Sep 01 | Business
German business confidence falls
22 Aug 01 | Business
Germany's feeling the pinch
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