EU Warns Germany Over Budget Deficit

Despite plans to reform its labor market and social system, Germany will fail to meet the criteria of the European Union pact ensuring the stability of its common currency, the euro, in 2003. Nor will it be able to achieve a balanced budget as previously planned by 2006.

"We can't make it by 2006 any more unless there is an economic miracle," Finance Minister Hans Eichel told the newsweekly Der Spiegel over the weekend. But in a country with unemployment at nearly 4.5 million and growing, an economic miracle is highly unlikely.

The news comes as a political blow to Eichel, who has made shrinking deficit spending and balancing the federal budget his key policy goal. Until recently, Eichel had forecast a cut in deficit spending to 2.7 percent this year.

Opposition politicians immediately demanded Eichel's resignation. "I'm not one to make regular resignation demands," said Friedrich Merz, the deputy chairman of the parliamentary group of the conservative Christian Democratic Union. "But what has happened in the past days, surely that is enough reason to say that the finance minister has failed across the board and personally, too."

But German Chancellor Gerhard Schröder has come out in support of his finance minister, telling public broadcaster ZDF on Monday that "there is no discussion about Eichel" and that he could keep his ministry post through the end of his term in 2006.

A fiscal flu

Germany is not alone in straying from the Stability Pact's stringent criteria -- and EU leaders fear the fiscal flu could spread to other euro zone countries.

France has also had its name added to the EU's fiscal "black book." France has repeatedly stated it will not meet the rules of the pact, which stipulates that government deficit spending may not exceed 3 percent of gross domestic product. With both Germany and France failing to meet the requirements, European Union officials fear other countries will have less motivation to follow the pact and that, ultimately, the euro could be weakened.

"(European Economic and Monetary Affairs Commissioner Pedro) Solbes is afraid that if Germany fails to meet the three percent limit three consecutive times that the French and Italians won't see any reason to continue to adhere to the stability pact," an unnamed German government source told the Financial Times Deutschland newspaper.

In a telephone conversation with Eichel over the weekend, Solbes warned Germany that it must adhere to the provisions of the Stability and Growth Pact by 2004. "Next year, the nominal deficit must fall below the 3 percent limit," a spokesman for Solbes told the newspaper.

But Solbes' warning may find little resonance in Berlin. Chancellor Schröder himself has questioned the logic of the 3-percent ceiling on deficit spending. During the devastating floods last summer in eastern Germany and again during his reelection campaign, Schröder criticized the stringent parameters laid out in the pact.

With staggering unemployment of nearly 4.5 million -- the highest level since German reunification -- and uncertainty about the extent to which reforms of Germany's social system and labor market -- it is unlikely Germany will be able to meet its own goals for balancing the budget.

"A balanced 2006 budget would require growth rates that I cannot expect and if achieving this meant cutting spending as much as revenues are falling, or giving up the 2005 tax reform, I would not be ready for it," German Chancellor Gerhard Schröder told ZDF.

A fierce political debate

Schröder is currently seeking to push through a package of reforms that will reduce unemployment and retirement benefits that are pushing Berlin's deficit spending through the roof. The plan also calls for a loosening of the country's labor laws to make hiring and firing easier. But Schröder is facing considerable resistance from deeply entrenched unions as well as the left wing of his own party, the Social Democrats.

The somnambulistic pace of negotiations surrounding the reform package has forced the government to undertake other measures to fill the budget gap. Last week, the government announced it would increase its tax on cigarettes by €1 per pack. Despite that effort, Berlin is still anticipating a budget shortfall in excess of the previously planned 18.9 billion. Still, the cigarette tax is only expected to bring in €4 billion for the country's public healthcare fund, which is itself anticipating a €4.5 billion shortfall. Opposition politicians have warned the government against any increases to the federal sales tax, which is currently 16 percent.

For his part, Eichel says the government is still planning to better balance its budget. "We haven't failed in consolidating (the budget), it's just going to take longer," Eichel said his interview with Der Spiegel.

The EU has already issued an "excessive deficit procedure" against Germany and the country faces massive fines if it is unable to balance its budget by 2006.

It remains possible that the German Government may be forced to introduce future tax increases in its bid to balance the books and escape EU action.