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Last Updated: Tuesday, 14 December 2004, 21:23 GMT
Can the European Stability Pact survive?
By Manuela Saragosa
BBC Europe Business Reporter

EU Commissioner for Economic and monetary affairs, Joaquim Almunia
Does the EU's climbdown signal an end to the Pact?

The European Commission is giving up on its attempts to hold France and Germany to account for repeatedly breaching the financial rules governing the 12 countries that use the euro, effectively giving ground to Paris and Berlin in its three year battle over the issue.

Those financial rules are spelled out in the European Union's Growth and Stability Pact.

Among other things, the Pact says that a country's budget deficit should amount to no more than 3% of gross domestic product.

France and Germany have been in breach of that limit since 2002.

To some, the Commission's decision not to impose sanctions on the EU's two biggest economies is a sign that Brussels is admitting that the Pact is well and truly finished, ending the first chapter in the Commission's attempts to co-ordinate national economic policies across the European Union.

Rules and regulations

The question is: What will now replace Growth and Stability Pact?

There is always this balance between the wish for economic growth and for economic stimulus, and on other hand the need to avoid a slide into escalating deficits
Hans Marten, European Policy Centre
After all, there needs to be some sort of guarantee that EU member states won't give in to sloppy state finances.

No-one wants to see eurozone countries start racking up large deficits as that would raise the cost of borrowing for all countries involved.

The answer will become clearer over the next few months as EU member states debate reforms to the Pact.

France and Germany aren't the only countries that have struggled to meet its limitations amid an economic slowdown.

Ten of the EU's 25 members are currently in breach of the deficit rule and there are many other governments that have already asked for the rules to be watered down.

Italy's prime minister, Silvio Berlusconi, for example, has described the Pact's rule on budget deficits as "stupid."

Their antagonism to it is part of the reason why Paris and Berlin have evaded potentially billions of dollars in fines.

Off the hook

The Commission is the Pact's policeman. But it is other EU governments who agreed to let France and Germany off the hook in November last year, when finance ministers agreed to put the threat of penalties for deficit breaches on hold.

The Commission fought that decision at the European Court of Justice and in July this year it won its case.

It soon realised, however, that it threats of sanctions against Paris and Berlin were toothless if other EU member states weren't going to play ball.

Many economists believe that a revamped and reformed Stability Pact will include clauses that allow for exemption from its strict rules on government spending in times of economic trouble.

The Commission's decision to hold back from pursuing France and Germany may well be a way to buy time, allowing EU finance ministers to come to some agreement.

Balancing act

"We need a flexible interpretation of the Pact," says Hans Marten, chief executive of the Brussels-based think tank, the European Policy Centre.

"There is always this balance between the wish for economic growth and for economic stimulus, and on other hand the need to avoid a slide into escalating deficits.

"That was the American path of creating growth, by building up large deficits and you see what that has meant in terms of undermining confidence in the dollar. We want to avoid that," he added.

So far the financial markets have shrugged off any breaches of the Pact's rules.

The euro has strengthened against the dollar in recent months, a sign if any that the markets at least are confident the Pact's demise won't lead to big budget deficits throughout Europe.

EC calls truce in deficit battle
14 Dec 04 |  Business
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24 Jun 04 |  Business

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