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Tuesday, 5 November, 2002, 15:11 GMT
Germany braces for budget criticism
Hans Eichel
German finance minister Hans Eichel may cut spending
Germany is facing the humiliation of a formal reprimand from the European Commission for its growing budget deficit.

German finance minister Hans Eichel has admitted that Europe's biggest economy will this year exceed the 3% budget deficit allowed under the EU rules.

And next week it will be formally warned by the European Commission to mend its ways or face economic sanctions.

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 is ironic, given that Germany was the main architect of the Stability and Growth Pact, a set of rules designed to prevent countries like Italy from overspending after the euro was introduced.

The Commission says that Germany's deficit could be as high as 3.7%, and it has already warned Portugal, with a 4.7% deficit, that it faces fines that could ultimately amount to 5% of its GDP.

France and Italy are also expected to come close to the 3% limit this year.

Urgent action needed

Germany has promised to take corrective action, including huge cuts in pension and healthcare provision, to stem its growing deficit.

But the basic problem is the slow German economy, which is being eclipsed in Europe by its more robust neighbours like France and Spain.

The Spanish central bank warned that countries with "excessive" deficits should carry out "structural reforms" to make themselves more efficient.

Spain, along with the UK, has been the main advocate within the EU of further liberalisation of labour markets, ending cushy labour laws and job protection.

Role of the ECB

The news will also throw a spotlight on the role of the European Central Bank, which sets interest rates across the whole 12 member eurozone.

The ECB has kept rates unchanged at 4.5% for most of the year, as the German economy has weakened.

It will decide on Thursday whether to change them - and most observers expect little movement despite the prospect of a US rate cut.

European Commissioner for Monetary Affairs, Pedro Solbes
Mr Solbes is pushing for Germany's reprimand
The ECB's high interest rates have helped boost its currency, the euro, which moved above the level of $1 last week for the first time in three months.

Critics argue the ECB should be cutting rates to boost economic growth, rather than worrying about inflation in countries like Spain and Ireland.

But others say the scenario only goes to prove that a "one size fits all" economic policy does not work.

Many are also critical of the narrow criteria of the stability pact, with its fixed limit of a 3% budget deficit whatever the state of the economy.

Some economists argue that it should be revised so countries in a recession would be allowed to borrow more - similar to the rule the UK government is applying to its own finances.

However, many smaller countries in the eurozone say that they have gone through the pain of budget cuts to meet the ECB rules, and they strongly object to any exemptions for the big players.

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