July 27, 2002

Portugal Faces Sanctions Over Deficit


FRANKFURT, July 26 Europe's monetary union is facing one of its first major tests, as Portugal disclosed late Thursday that its budget deficit had soared above the limit set by the European Union.

The European Commission immediately began a sanctions procedure against the Portuguese government. Under the union's rules, Portugal could be assessed heavy fines if it fails to get its deficit below 3 percent of its gross domestic product.

The figure for 2001 was 4.1 percent, Portugal's finance minister, Manuela Ferreira Leite, said late Thursday. She promised "a profound reduction, a violent one," to bring it down to 2.8 percent for 2002.

That Portugal would breach the deficit limit had been expected, but the scale of the breach surprised and angered European Union officials, who chided the government in Lisbon for what they called incomplete and flawed economic data.

Portugal discovered "serious omissions in the production of government deficit and debt data," Pedro Solbes, the union's commissioner for economic and monetary affairs, said in a statement.

Reaction from other European capitals was muted, however, perhaps because Portugal is not the only country at risk of violating the limit. Budget gaps are widening in France and in Germany, which is perilously close to the 3 percent limit this year.

Portugal and Germany narrowly avoided receiving formal warning letters from the European Commission in February, an escape that experts attribute to Germany's influential role in the monetary union.

When the Stability and Growth Pact, which sets the rules for the monetary union, was adopted in 1997, the German government was a main proponent of strict limits on members' budget deficits, arguing that profligate borrowing by governments would undermine Europe's new currency, the euro. The 12 nations that signed the pact pledged to balance their budgets by 2004.

There is little evidence that Portugal's woes have had much of an effect on the euro, at least so far. The currency has risen 14 percent in value in the last three months, regaining parity with the dollar; it traded at 98.87 cents today in New York.

But experts said that if Brussels did not deal firmly with Portugal by withholding development funds and imposing fines the credibility of Europe's unified monetary policy would suffer.

"They should be tough," said Daniel Gros, the director of the Center for European Policy Studies, a research institute in Brussels. "You have to impose sanctions, otherwise everybody will do the same thing."

Mr. Gros said Portugal's previous government, which was defeated in elections in March, tried to cover up the size of the deficit by shifting some public expenses to state-owned corporations. "This was a combination of really bad information and a government that knew an election was coming," he said.

Under European Union rules, Portugal could be fined an amount equal to 0.5 percent of its gross domestic product, or more than $670 million. But such a penalty can only be imposed by a vote of the finance ministers of fellow union members.

European Union officials said Portugal would be given about a year to get its financial house in order before penalties were considered. The new Social Democratic government in Lisbon has said it will lay off government workers, close public agencies and raise its top value-added tax rate to 19 percent from 17 percent.

"It would be difficult to imagine sanctions if the country acts," said Gerassimos Thomas, a commission spokesman.

Skeptical economists say Portugal's ballooning deficit is proof of the futility of trying to control government policies with numerical rules. They predict that more governments will soon soar past the 3 percent limit, and that few will balance their budgets by 2004 as promised.

These pledges, the economists noted, were based on achieving certain rates of economic growth. While Europe is in the midst of a fragile recovery, analysts fear it could be hobbled by the recent market turmoil in the United States, which has spread to European markets.

"What is this fetish for balanced budgets?" said Peter Dixon, chief economist at Commerzbank Securities in London. "It doesn't allow for the fact that when growth slows, governments have to be able to spend money to stimulate the economy. It imposes a straitjacket on growth."

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