Concessions to French put stability pact under fresh strain

The credibility of the euro's enfeebled rule book took a fresh battering yesterday as France was given more time to produce a plan to get its public finances under control.

During a tense meeting of EU finance ministers in Brussels, Berlin backed Paris in opposing moves by the European Commission to act against persistent breaches by the French of the rules governing the single currency.

Yesterday's postponement of a confrontation with France marks another, near-death experience for the so-called Stability and Growth Pact, once regarded as the foundation stone of the euro.

It is also a humiliation for Pedro Solbes, the European Commissioner responsible for the euro, who admitted that he wanted a decision yesterday on his recommendations for action against France.

Mr Solbes, who is the guardian of the pact, faces pressure to be tough from three small eurozone nations, the Netherlands, Austria and Finland, all of which have obeyed the rules. As the Austrian finance minister, Karl Heinz Grasser, put it acidly yesterday "each country that did its homework" by getting its finances under control is "paying the bill for the policies of France and Germany."

But Germany, which knows it is next in the firing line after France, has hardened its position against European Commission plans toenforce the pact. With the two biggest economies in Euroland now ranged against him, Mr Solbes is expected to agree a fudge at the meeting of EU finance ministers on 24 November.

In the words of Ireland's finance minister, Charlie McCreevy, this now promises to be a "decisive date". But whether that meeting manages to keep the pact on a political life support system, or finally buries it, the rule book is already a dead letter.

The irony is that one of the undertakers is none other than Germany, the prime architect of the pact. Drawn up to soothe German anxieties about the loss of the D-mark, the pact was a Bundesbank-inspired creation, the quid pro quo for its entry into the euro and the baby of the then German finance minister, Theo Waigel.

Its purpose was to ensure that Germany's economic might was not undermined by the profligacy of less virtuous southern Europeans. The fear was that soaraway public spending, say in Italy, would push up inflation and force the European Central Bank to raise interest rates for the whole bloc.

Euro members are expected to move their public finances into surplus or close to balance in the medium term. But the pact also lays down a budget deficit ceiling of 3 per cent of gross domestic product. If broken consistently, this can expose a nation to fines of up to 0.5 per cent of its gross domestic product.

This may have seemed sensible to its authors in 1997, but the pact has been an economic and political disaster. For one thing, it has constrained much-needed growth, one of its supposed objectives. For another, it is a political - not a judicial - agreement under which the member states must act as judges and vote to apply penalties on fellow miscreants.

Buffeted by the economic slowdown, eurozone member states have behaved with all the obedience of adolescents confronted by a strict, but unenforceable, parental edict. Little wonder the European Commission president himself described the rules as "stupid".

France has emerged as the most troublesome test. After recording a deficit of 3.1 per cent last year, and an estimated 4 per cent this year, Paris is heading for a deficit of at 3.6 per cent in 2004. Politically defiant, it is now clearly in breach for three consecutive years - the point at which fines could begin to be triggered.

Under the pact's procedures, France has already been declared in excessive deficit and, under the EU's treaty article 104, paragraph seven, asked to bring the deficit under 3 per cent "within a given period".

The focus has now moved on to whether to launch the next stage, under paragraph eight of the same article. This reads: "Where it establishes that there has been no effective action in response to its recommendations within the period laid down, the Council [of EU finance ministers] may make its recommendations public." If this move is backed, it brings closer the possibility that France could be fined.

Germany's recent rally to the defence of France is motivated by more than a little self-interest. Its Chancellor, Gerhard Schröder, hoped for leniency on the basis that his finance ministry has promised to put its house in order and stop the breach taking place for three consecutive years.

Unfortunately, with growth sluggish and revenues low, the measures promised by Berlin now look insufficient to bring the ballooning deficit under control. Worse, from the Commission's point of view, the German government is still planning to proceed with tax cuts next year.

Aware of the threat of a political humiliation, Berlin has set its lawyers on to the terms of the pact. It now opposes the application of paragraph eight to France, pointing out that the wording says only that ministers "may" take this step - not that they must. Berlin wants procedures against itself to be slowed, to give it more time to hit the 3 per cent ceiling.

Mr Solbes is caught between a rock and a hard place. Yesterday's meeting showed that, if he forces the issue to a vote on 24 November, he would have the support of probably just the Netherlands, Austria and Finland. That would mean defeat and devastating consequences for his credibility.

The more likely alternative - a fudge - is scarcely palatable either. Mr Solbes has already demanded a tightening of French finances next year to the tune of €6bn but offered France more time to comply than it could have expected. The French finance minister, Francis Mer, promised yesterday to seek "additional savings" in 2004, possibly through health reforms and ditching one public holiday. But he made it clear that the €6bn sought is out of the question.

But does the slow and public death of the pact matter? One diplomat points out: "The euro is rising against the dollar and the markets are more concerned about structural reforms than about the pact."

While that may be true, the failure to alight on a set of enforceable rules remains an Achilles heel.

There has been a broad consensus on the type of changes needed for more than one year. Most nations want to stick to the 3 per cent figure as a target but interpret it flexibly, while creating a system that forces countries to consolidate during upturns. This would allow them to survive recessions without breaking the rules. There is also agreement on the need to allow nations with low debt to borrow more.

In other words the task is a clear, if complex, one - to reform a failing system rather than defend a set of rules that cannot be enforced.