Euro crisis rules may let Germany off budget hook

The European Union is poised to water down the euro's rulebook if there is war in Iraq in a move that could let Germany off the hook as it braces itself for a sharp economic slowdown.

With the German government already in breach of the rules, and France in trouble, the decision could mean the end of the so-called stability and growth pact in its current form.

But it could also throw a lifeline to the ailing coalition government of Gerhard Schröder, which has been humiliated by its inability to conform to the pact that it helped to create.

Since he was re-elected last year, Mr Schröder's popularity has slumped. Unemployment hit 4.6 million last month, its highest level for five years, and economists predict that the country is on the verge of recession.

The Chancellor's party suffered a drubbing in regional elections at the hands of the opposition conservatives earlier this month, largely because of his failure to tackle the country's unemployment crisis.

With Portugal, Germany is in breach of the pact, which states that budget deficits must not exceed 3 per cent of gross domestic product. Germany's deficit reached 3.75 per cent of GDP last year, and this year the 3 per cent figure might be broken again.

This led the European Commission to begin proceedings against Berlin that could involve hefty fines. Mr Schröder is now courting EU allies to help him out of the trouble.

When asked about reports that France, Germany and Britain – which is not a member of the eurozone – were discussing a relaxation of the pact if the war caused further slowdown, the European Commission refused to rule out such an option.

"If there were to be a war, then we would look at any measures that were appropriate and might need to be taken," Jonathan Todd, a commission spokesman, said yesterday, adding that the EU would "cross that bridge when we come to it".

A German finance ministry spokesman said: "We are not talking at the moment about weakening or reinterpreting the stability pact but how to adapt it to the current economic situation." This, he said, applied to "the possibility of an Iraq war", although "crisis planning is not at the moment the central scenario".

Franz Müntefering, the Social Democrat parliamentary leader, said: "It is important for European countries to discuss what is to be done if it comes to the worst." The Social Democrats are said to be banking on a clause in the pact that allows the deficit criteria to be suspended "under exceptional circumstances", which they say would include war with Iraq.

Mr Schröder wants to limit cuts in investment in the event of a war to prevent further damage to Germany's sluggish economy. In domestic terms the move would make sense, but it would almost certainly deepen the budget crisis.

France, which has been warned that it could breach the deficit criteria, has also lobbied for the rules to be relaxed. Paris says it will stick with a programme of tax cuts, arguing that, in times of economic slowdown, stimulating growth is more important than sticking to the letter of the budget rules.

But such changes could further undermine the fragile credibility of the pact. So difficult has it been for some eurozone nations to observe the rules that the European Commission president, Romano Prodi, described them last year as "stupid".