Ministers must decide how to handle the outsiders

IN agreeing to put in place a series of sanctions in the Stability Pact against those inside the single currency who misbehave financially, the EU finance ministers have begged an enormous question. Why not similar constraints for those outside? They, after all, are just as likely, and arguably more likely, to upset the stability of post EMU currency relationships.

It is a question that will be asked again and again of the Minister for Finance, Mr Quinn, as Ireland ponders the likely prospect of EMU membership with its nearest and biggest trading partner firmly outside.

The answer is straightforward - because the Maastricht Treaty does not provide for it, and the treaty is sacrosanct. To amend it would be to open up "the box of Pandora", as the Monetary Affairs Commissioner, Mr Yves Thibault de Silguy, puts it quaintly. The treaty does, however, provide for the sorts of measures the Stability Pact is proposing for the "ins".

Ireland is not alone, however, in its concern that those outside EMU should face more than political and market constraints on their freedom to devalue. And the challenge facing finance ministers after this weekend's success in shaping the new exchange rate system is to devise such constraints within the terms of the treaty.

They have three key weapons in their armoury.

. First, the Treaty provides a legal obligation in (Article 109(m)) that members should treat their currency as a matter of common concern.

. Second, there is already provision for an annual review by the Council of Ministers of each member state's convergence programme - a strengthening of this system of multilateral supervision is seen as providing the mechanism for control.

The aim, Mr Quinn says, is in effect to make the convergence programme a mirror image of the stability programme of the "ins". The British Chancellor, Mr Ken Clarke, made it clear on Saturday there could be no question of presubmission" of a programme to the European partners before it has been approved by the Commons - we can't give the impression of being dictated to by Brussels!

. Third, only for those inside the ERM2, there is the possibility that the European Central Bank (ECB) may refuse to intervene in support of a currency when it is in trouble. That, Commission sources are saying off the record, is what they hope will be the sanction against irresponsible economic policies.

And the President of the European Monetary Institute (EMI), precursor to the European Central Bank, Mr Alexandre Lamfalussy, made clear at the final press conference, that the bank's normally automatic intervention when currencies reached the outer limit of their band is subject to such intervention not jeopardising either the stability of prices or the credibility of the new exchange rate mechanism.

Yes, he says, countries in ERM2 may lose the support of the bank if they do not behave, but he believes the likelihood of the use of such sanctions to be extremely limited.

Fair enough. But what about countries like Britain which refuse to join ERM2, let alone, the single currency? The answer from Mr Quinn and ministers is still only that the imperatives of the market and Britain's political commitment to fiscal prudence make the question of sanctions unnecessary.

The problem is that many believe sterling's movement is not determined by Britain economic fundamentals alone, but also crucially by its relationship to the dollar. A plunging dollar could drag down sterling against the euro, and Ireland would take a very nasty hit.

Although no agreement has been reached on maximum band widths, sources suggest the present 15 per cent will be maintained. But provision is also to be made for bilateral agreement to be reached between individual countries and the ECB to allow their currencies to fluctuate within narrower bands with the support of the bank.

Intervention by the central bank and national central banks in support of a currency which has hit the 5 per cent limit will normally be automatic, but there will also be voluntary, mutually agreed intervention to maintain the stability of the system and help currencies before they reach the other limits of bands.

The system's other crucial difference with the current Exchange Rate Mechanism (ERM) is that the ECB, at the insistence of the Germans and the EMI, will have a say in setting a currency's point of entry to the system and a right to initiate the confidential procedure that leads to a realignment.

This, it is argued, will help to avoid what many have seen as the "virility test" in the old ERM - effectively national pride and domestic political considerations delaying a proposal for realignment, often with the result that ministers are closing stable doors after horses have bolted.