January 31, 2002

Germany and Portugal Face Warnings to Rein in Deficits


BRUSSELS, Jan. 30 — The European Commission recommended today that Germany and Portugal be sent early warnings over the size of their national budget deficits.

The public chastisement comes at a delicate time for Chancellor Gerhard Schröder's government, as economic policy becomes an important campaign issue with German elections looming this fall.

The commission expects Germany's budget deficit to rise to 2.7 percent of gross domestic product this year from an estimated 2.6 percent in 2001, dangerously close to the 3 percent ceiling set in a stability pact signed by all 15 members of the European Union in 1997.

That pact calls on the commission, the European Union's executive body, to issue early warnings when a member country's deficit approaches the ceiling.

"If we fail to take action in these clear-cut cases, it is difficult to see when an `early warning' could ever be issued," said Pedro Solbes, commissioner for economic and monetary affairs, at a news conference.

"The credibility of the pact is at stake," he said. "If we don't act now, we could be criticized for not doing our job properly."

Mr. Solbes said he was not recommending that the German finance ministry raise taxes or cut spending. The 2002 budget outlined by the finance minister, Hans Eichel, "should be implemented as planned," he said, pointing out that the German economy had suffered more than other European economies from the world slowdown. "This has had an impact on the nominal budget deficit," he said.

But he added that the worsening budget deficit could in part be a result of "slippage" in spending by Germany's regional governments and on rising spending on health.

"Budgetary developments should be monitored closely at all levels of government in 2002," Mr. Solbes said. "Slippages should be avoided so that the deficit does not increase any further."

It is the first time the commission has applied its early warning procedure, which can ultimately lead to hefty fines for member states if they breach the deficit ceiling.

The early warnings do not become official until they are endorsed by a majority of the 15 national finance ministers. The issue is likely to dominate the next finance ministers' meeting, on Feb. 12.

The value of the euro hardly flinched in response to the chastisement of Germany, the single largest economy in the euro zone. It stood at 86.52 cents shortly after the commission issued its recommendation.

"We were not surprised by the decision to recommend a warning to Germany," said Thomas Mayer, chief euro zone economist with Goldman, Sachs.

The political significance of the commission's move outweighs its economic impact, he said. "The awkward thing about this decision is that the commission is issuing a warning but not calling for a change in Germany's budget policy," he said. "This will be tricky to convey to the electorate."

The opposition Christian Democratic Union and the Christian Social Union "will make use of this," Mr. Mayer said. "It will provide an extra bullet to fire" at Mr. Schröder's Social Democratic Party and his center-left coalition government.

Mr. Mayer said he did not expect Germany's budget deficit to reach 3 percent of gross domestic product. "If consensus G.D.P. growth estimates of 0.7 percent materialize," he said, it will not reach that level.

But he added that if the German economy failed to grow this year, "it would be hard to avoid" a 3 percent deficit.

Mr. Solbes also warned against complacency. "There is considerable uncertainty on Germany's economic outlook for 2002," he said.

German G.D.P. fell by an estimated 1 percent in the final quarter of last year, and by 0.5 percent in the previous three months, Mr. Mayer said. Analysts expect the first quarter of this year to see zero growth, with a gradual recovery beginning in the second quarter.

Like Germany's, Portugal's budget deficit for 2001 is expected to be well over 2 percent, and more than 1 percentage point larger than the target it set itself for last year. Mr. Solbes said structural reasons were as important as the cyclical impact of the global downturn, and urged the Portuguese government to make an extra effort to tackle revenue shortfalls.

The commission gave more favorable budget assessments of six other economies — France, Britain, Italy, Spain, Greece and Ireland.

But the commission said France's budget stability program was not ambitious enough, and it called on the country to speed efforts to balance its budget by 2004 at the latest.

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