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Brussels Waves Big Stick Over German Deficit

Germany could face billions of euros in penalties for violating the European Union’s stability pact. But Chancellor Schröder hopes the eurocrats won’t be too rigid in applying the rules.

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Finance Minister Eichel says Germany can't make deficit limit

Europe's largest economy is facing a hefty fine from Brussels because it can't stick to the rules of a pact it helped create.

German Finance Minister Hans Eichel confirmed on Wednesday what many economists had been predicting all along: the country will exceed the three percent budget deficit limit required by the European Union's economic stability pact.

With the admission, Eichel went back on earlier pledges that Germany would on no account exceed the deficit limit. He said lower-than-expected tax revenues resulting in a 10 billion euro budget shortfall had made new debt unavoidable. He blamed the problems on a downturn in the world economy and said he was confident Berlin would meet the stability pact targets in 2003 and 2004.

The pact demands that the EU's 16 nations not have budget deficits that exceed three percent of its gross domestic product (GDP). The rules, which former German Finance Minister Theo Waigel helped draft, are intended to prevent countries within the eurozone from running lax fiscal policies at the expense of other eurozone members.

EU prepared to levy fine on Germany

Berlin already avoided an official warning from the European Commission in February by promising to balance its budget by 2004. But with Italy and France also unlikely to balance their budgets within the next two years, the EU has now been forced to relax the rule, with 2006 the likely new deadline.

Reacting to Eichel's announcement, EU Finance Commissioner Pedro Solbes said the Commission would institute formal deficit violation proceedings against Europe's largest economy if it fails to meet the stability criteria. The commission invoked the procedure for the first time earlier on Wednesday, issuing an official warning to Portugal for failing to meet the deficit criteria this year.

Offending governments have to lodge a deposit of between 0.2 and 0.5 percent of GDP with the European Commission at zero interest. If the deficit is not corrected within two years, the deposit is converted into a fine, which in Germany’s case could run into billions of euros.

The roots of the problem are mainly at home

Many experts believe the global economic slowdown is only partially to blame for Germany’s current problems. Although the bursting of America’s economic bubble in particular has led to a cutback in foreign investment and a sharp fall in European share prices, German exports have still been growing.

The real cause of the weakness is a fall in consumer spending and investment, say economic observers. This has also been compounded by a fall in revenues from taxation. Klaus Zimmermann from the Berlin-based German Institute for Economic Research told DW-RADIO that Eichel’s admission was expected.

"There are basically domestic reasons for the problem," he says. "Last year’s tax reform was bound to result in steeply decreasing public revenues. On the other hand the government was too anxious to keep to the deficit limit earlier this year and failed to take countermeasures when the economy was starting to cool."

Caught between a rock and a hard place

Germany now finds itself in a double bind. Most experts agree that, faced with a slowing economy, the government would normally lower interest rates to try and fire it up again. But interest rates across the Euro-zone are set by the European Central Bank (ECB), which is against any reduction, so this is an option that Eichel no longer has. His only other course of action is to use fiscal policy to support the economy, which is to a large extent ruled out by the stability pact's three percent limit.

Meeting in Paris earlier this week, Chancellor Gerhard Schröder and the French president, Jacques Chirac, agreed that the pact should be interpreted in a flexible way in view of the current international situation. ECB president Wim Duisenberg has already rejected any relaxation of the three-percent rule.

Germany’s conservatives cry foul

Germany’s conservative opposition says the deficit violation proves that the government deceived voters in the run-up to last month’s election. The Christian Democrats’ leader Angela Merkel called it "an outrage beyond description. "Even though the Social Democrats and their Green allies have known this for a long time," she said, "their forecasts were wrong. This goes to show that Schröder simply lied to the voters in the election."

With business leaders saying new government plans to raise revenues and cut spending to plug holes in the 2003 budget will destroy jobs and kill off growth, it looks as if Germans will have to prepare for a few lean years.