By Swaha Pattanaik
BRUSSELS, Nov 28 - The European Commission said on Wednesday it does not expect euro zone countries' budget deficits to exceed three percent of their national output even though fiscal policy has been eased as economies have slowed.
In a report which represents the position the European Union's executive will take at next week's meeting of euro zone finance ministers and at the December meeting of EU heads of state and government, it also said Europe's Stability and Growth Pact on fiscal discpline was working "reasonably well".
But it added the pact's procedures were being strengthened, that the current economic downturn underlined the need to get budgets into balance or surplus in the medium-term, and that an appropriate policy mix would involve "a cautious fiscal policy".
It also said there could be more scope for monetary policy action if price pressures continued to ease.
A week after the Commission slashed its euro zone growth forecasts, it said monetary and budget steps had already been taken to counteract the economic slowdown without jeopardising medium-term objectives.
It said that while there had been a deterioration in euro zone countries' budget positions, it was not expecting deficits to rise beyond the three percent of gross domestic product level after which countries risk being fined.
"The deterioration in government finances should not lead, however, to the appearance of an excessive deficit."
A Commission official said that while the procedures of the pact were working relatively well, more work was needed.
"The procedures have worked well but a number of countries have not taken the opportunity of strong growth (in the past) to improve their budget positions," he said.
Germany, France, Italy, and Portugal were told earlier this year that they had less room for budget slippage than their euro zone peers at a time of slowing growth because they had not built up a large enough fiscal cushion in good times.
The Commission repeated its prediction that inflation would fall below two percent at the beginning of 2002. It said abating price pressures could leave more room for rate cuts, and that budget discipline could also play a role.
"Decreasing price pressures and the declining trend in inflation may provide further scope for monetary policy, depending on the continuation of wage moderation, the development of oil and other commodity prices, the exchange rate and budgetary discipline."
DEMAND INSUFFICIENT
The Commission said its analysis showed euro zone domestic demand had proved to be insufficient. Still, it said changes in the economy in the past decade meant that its unemployment rate could be lower without triggering inflation pressures than was the case eight to 10 years ago.
"The shift seems to have taken place in the run up to EMU (economic and monetary union)," it said.
"Structural reforms also seem to have played a role in this encouraging development."
The Commission termed the euro zone's investment performance "mediocre" and "disappointing" relative to the United States and said more flexible markets for labour and goods were needed to increase incentives to invest.
It said that while EU financial markets had become more integrated, particularly following the 1999 launch of the single currency, more work was needed on this front.
"Any weakening in the commitment of member states to the integration process would be likely to undermine financial market confidence," it said.