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The EU Stability Pact – Someone Has Slammed the Stable Door!

by Bill Blevins, Financial Correspondent
Blevins Franks International Limited

The EU’s Stability and Growth Pact, as set up in 1997, stipulated that Eurozone countries must endeavour to have their budgets as near to balance as possible by 2004. However, overspending by France, Italy and Germany has meant that European Finance Ministers have had to make a last effort to save the pact and prevent long-term damage to the Euro whilst at a meeting in Spain in June they were forced to agree to introduce a certain amount of leeway. Primarily France has led the recent challenges to the EU’s budgetary goals. Before the EU meeting in Spain, Berlin leaked estimates that demonstrated that France's budget deficit could increase to 2.6 per cent of GDP this year. In fact this could be higher if the new centre-right government of Jean-Pierre Raffarin carries out an election pledge to cut taxes by 30 billion Euros and increase spending.

This information, along with a comment made by Raffarin in a radio interview about the pact not being “written in stone”, caused concern amongst EU diplomats. They commented that since Germany and Portugal escaped unpunished for testing the pact, (although they were publicly reprimanded) this could have encouraged France to believe that there was no need to stick to the pact.

Pedro Solbes, the EU Monetary Affairs Commissioner, tried to remind member states of their commitments. "I urge member states to make a last effort to reach a close balance or surplus position by 2004 at the latest," he said.

However it came as no surprise when the centre-right French Government took the first step in its campaign to loosen the provisions of the pact. French Industry Minister and former European parliament speaker, Nicole Fontaine, suggested that there should be more emphasis on economic growth within the content of the Eurozone pact. "There is room for manoeuvre" she observed, adding, We tend to forget that this is the pact for stability and growth".

France dug its heels in at the meeting and the final agreement was that France and other nations with budget deficit problems will only have to get "close to balance by 2004, with a margin for deficit of up to 0.5 per cent of GDP that year.

Paris was allowed to make its commitment subject to an economic growth rider, stating that its debt pledge was subject to France achieving economic growth of at least 3 percent next year and the year after.

As well as France, Germany, Italy and Portugal have budgetary concerns and have all been offered a certain degree of leeway in the reinterpreted Stability Pact. But France remains the main worry and has gone as far as to warn that it may not achieve a balance between income and spending until 2007, as it wants to implement tax cuts promised by Jaques Chirac in the recent presidential campaign.

As Solbes pointed out "Tax cuts must have a neutral impact on the budget" adding that they therefore must be matched by spending cuts. "Above all, it’s key that the date remains 2004 and that they forget about 2007." he said.

According to reports Solbes believes it would have been better to leave the Stability Pact untouched. In an interview with Italian Financial daily, Il Sole 24 Ore, he said "As far as we are concerned, it would have been better to leave things as they are." Asked if there were any dangers with the new version of the pact he replied "No, but a few uncertainties over interpretation worry me".

He said that France’s unilateral declaration, that any budget balance in 2004 would depend on gross domestic product of "at least three per cent" in 2003-2004 was a concern. "Our forecasts for (France’s) growth in 2004, are for around 3 per cent, but nobody can say what the final figure will be."

The French economy is expected to grow by just 1.5 percent this year. Originally, it was the Germans who imposed the Stability Pact as a condition for giving up the Deutschmark in order to prevent the Euro currency being weakened by states with a history of chronic inflation.

They are now outraged at the suggestion that their own deficit, which touched 2.7 per cent last year and is expected to fall slightly to 2.5 per cent in 2002, is comparable to the fiscal slackening now visible across the EU. Berlin claims that it suffered an "asymmetric shock" after 11th September, experiencing a sharp slowdown in industrial exports. It has since reined in spending, despite unemployment of 4.3 million and economic conditions hovering near recession.

By contrast, France and Italy appear to have abandoned discipline to stimulate their economies. Italian leader Silvio Berlusconi, encouraged by the French carefree attitude, has announced he will not push through an emergency budget this year to bring spending under control.

The worst case is Portugal, which faces an exploding budget deficit predicted to be worse than the 3 per cent buffers next year, perhaps reaching 5 per cent.

The new centre-right government says it has inherited public finances in a catastrophic condition. It follows a credit and consumption boom - induced by the halving of interest rates on Portugal's entry into the Eurozone. The boom has now turned to a bust, making Portugal the test case of Euro's one-size-fits-all monetary system.

The potential collapse of the Stability Pact is causing heartburn for officials at the European Commission and the European Central Bank who must manage economic and monetary union. Commission officials warn that Eurozone countries need to reduce their budget deficits to cope with under-funded pension liabilities as the population grows older. Critics say the disintegration of the stability pact at such an early stage is a serious indictment of EMU.

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