EU upbeat on budget talks

The ministers are meeting in Madrid

European Union finance ministers have said they are confident they will be able to square French calls for greater budgetary leeway with an existing agreement limiting government spending.

Speaking mid-way through a round of talks expected to continue through Thursday night, Spanish finance chief Rodrigo Rato, who is chairing the meeting, said he was optimistic a solution would be reached.

"From the conversations I had this morning with my colleagues, I'm convinced the problems will be resolved," he said.

Failure to hammer out a deal would run the risk of undermining the 1997 Growth and Stability Pact, an agreement aimed at taming national deficits so as to contain inflation and reassure financial markets.

French dissent

The pact commits all 15 EU members to keep deficits below 3% of gross domestic product until 2003, and balancing their budgets by 2004.

But France, which wants to push through tax cuts promised by President Jacques Chirac in his 2002 presidential campaign, has said it may not be able to balance its books until 2007.

Portugal, which looks set to narrowly avoid breaching the 3% deficit limit this year, has signalled that it will join France in pushing for greater flexibility.

The ministers are exploring compromise deals which would allow EU countries to set their own deadlines for eliminating budget deficits based on economic growth forecasts.

The final compromise is likely to retain the 2004 deadline, while redefining it as a target for bringing budgets "close to balance."

ECB sounds the alarm

The prospect of a relaxation of the stability pact has prompted criticism from officials at the European Central Bank, which sets monetary policy for the eurozone area independently of national governments.

Nout Wellink, a member of the ECB's interest rate-setting governing council, said on Thursday that ministers should avoid loosening the agreed spending constraints at a time when the economic downturn is subjecting them to their first real test.

"I think (proposals to relax the stability pact) are a very unfortunate development, and I hope ministers will stay away from them," he told the Reuters news agency.

"It is the first test, and at the first test you shouldn't change things," he said.

Inflation fears

An increase in European governments' budget deficits would fuel inflationary pressures, putting the ECB under added pressure to push through growth-sapping interest rate increases.

There were concerns that some EU countries were not doing enough to bring their budget deficits under control even before France began pressing for a relaxation of the stability pact.

Earlier this week, the European Commission said in a report that eurozone economic powerhouses France and Germany, along with Italy and Portugal, were in danger of missing the 2004 deadline.

The budget squabbles have not so far affected the euro, which rose to a two-year high against the dollar on Thursday.