Nov. 25 (Bloomberg) -- Germany and France won extra time to reduce their budget deficits, overriding objections from four smaller countries that this risks the credibility of the euro by undermining European Union fiscal rules. The two largest economies in the dozen-nation euro region have been breaking EU rules since 2002 by running deficits larger than 3 percent of gross domestic product. The rules were created to protect the euro from governments running up debt. France and Germany gained enough backing to reject demands from the European Commission for additional savings in 2004, saying to do so would endanger the economic recovery. Spain, the Netherlands, Finland and Austria opposed the compromise.
``The commission deeply regrets that these proposals do not follow the spirit of the stability and growth pact,'' Monetary Affairs Commissioner Pedro Solbes said at a press conference in Brussels after a nine-hour meeting of finance ministers. Against the dollar, the European common currency gained to $1.1796 as of 1:55 p.m. in Tokyo, according to EBS, from $1.1772 late yesterday in New York. It rose to 129.05 yen from 128.69. Budget gaps are growing across the euro region as economic growth slides to an estimated 0.4 percent in 2003, the slowest pace in a decade. Deficits in Germany and France won't fall below the line until 2005 at the earliest, the commission forecasts. Germany designed the stability and growth pact, which threatens fines for deficit offenders, to prevent governments from fueling inflation and damaging the euro's stability by overspending.
`Murder' of the Pact
``The big countries are getting away with murder,'' said Daniel Gros, director of the Brussels-based Centre for European Policy Studies. ``Maybe they are murdering the stability pact.'' France won permission to cut next year's deficit by 1 billion euros ($1.2 billion), less than the 6 billion euros demanded by the commission. Germany stood by previously announced cuts of 13 billion euros, less than the 17 billion euros called for. ``This is the best mix between the need to follow the pact and the need given by the economic situation,'' French Finance Minister Francis Mer said. Germany's Hans Eichel spoke of a ``difficult'' compromise, ``but it is a realistic one.'' The French economy avoided recession as it returned to growth in the third quarter after shrinking 0.3 percent in the three months to June. Still, growth this year will be only 0.1 percent, the commission predicts. Germany sank into recession in the first half, prompting tax revenue to dwindle and unemployment to rise close to a five-year high, pushing up welfare costs. Chancellor Gerhard Schroeder is counting on tax cuts next year to help the economy get back on its feet after it grew 0.2 percent in the third quarter.
Court Order?
Asked whether the commission will seek an EU High Court order to force Germany and France to make more cuts, Solbes said he will ``reserve the right to examine and decide on possible subsequent actions.'' The European Central Bank has warned that repeated deficit breaches could saddle Europe with higher interest rates than the economy requires. Finance ministers from Greece and Austria said they may be stuck with higher borrowing costs because of the German and French deficits. ``You can't put it upon the Austrian taxpayer to pick up the bill for higher interest rates caused by deficits in France and Germany,'' said Austrian Finance Minister Karl-Heinz Grasser. All euro governments originally promised to get their budgets ``close to balance'' by 2002. Only seven of them -- Belgium, Spain, Ireland, Luxembourg, the Netherlands, Austria and Finland -- met that goal.
Borrowing Costs
European interest rates are at a half-century low of 2 percent as the economy recovers from a first half when Germany, Italy and the Netherlands were in recession. Germany's failure to control public spending may be dissuading bond investors. They are now charging the German government 17 basis points more than the U.S. government to borrow over 10 years, compared to an average difference of 3 basis points over the past six months. ``Deficits can have an effect on long-term interest rates, which indeed have been rising in the last few months,'' said Patrick Casselman, who helps oversee $96 billion at KBC Asset Management in Brussels. To be sure, Germany's and France's failure to stick to the rules hasn't undercut the euro, which reached a record high of $1.1978 last week. Spain, the Netherlands, Austria and Finland combine for 21 percent of the 12-nation economy and didn't have enough votes to force Germany and France to make deeper deficit cuts.
Dutch Criticism
Dutch Finance Minister Gerrit Zalm is planning 10.9 billion euros of spending cuts in 2004 to fight a widening deficit. Zalm criticized the compromise for France and Germany as being ``outside the pact. The pact is not applied.'' Also taking a hard line on budgets is the ECB, whose president, Jean-Claude Trichet, said Nov. 6 that the budget rules are being stretched ``to the limit.'' Deficit offenders can in theory be fined up to 0.5 percent of GDP. Belgian Finance Minister Didier Reynders said financial sanctions are unlikely. ``We aren't yet talking about sanctions,'' Reynders said. ``We hope never to reach that stage. The procedure is to apply pressure -- peer pressure.'' //www.bloomberg.com