Brussels fears for survival of ailing pact

The Minister for Finance, Mr McCreevy, insists there is no crisis and the Stability and Growth Pact will survive in its present form for at least another three years. But in Brussels, events this week have prompted fears among Commission officials that the pact is about to be thoroughly disabled.

EU finance ministers have postponed until November 25th a decision on whether to take stronger action against France for breaching the pact's budget deficit limit for the third year running. After repeated warnings and recommendations to Paris, the Economic and Monetary Affairs Commissioner, Mr Pedro Solbes, wants to move on to the next stage in disciplinary proceedings. This would involve setting out a detailed programme of action for France to reduce its deficit, with Paris presenting regular progress reports. If France failed to fulfil its obligations, it could face economic sanctions.

The French finance minister, Mr Francis Mer, promised on Tuesday a new plan to cut his government's deficit in 2004 by close to the 1 per cent the Commission demands. Mr Solbes described the move as "very encouraging" but the Commission is far from encouraged by a second element of the compromise plan, which is backed by Germany.

France and Germany, supported by Italy and Luxembourg, want to block any move to the tougher stage of disciplinary action, which they argue should only apply to countries refusing to co-operate with EU recommendations. Commission legal experts believe the Franco-German initiative is illegal under EU treaties, a view not shared by lawyers at the Council of Ministers.

More importantly, the Commission fears that, by effectively removing the threat of tough disciplinary measures, the proposal would reduce the pact to a set of unenforceable guidelines.

Mr McCreevy recalled wryly this week that the pact was first drawn up at the insistence of Germany, which feared inadequate budget discipline could undermine euro stability. Germany is now to the forefront of the attempt to save France from the pact's disciplinary measures.

Berlin's new, soft line owes more to domestic political considerations than to a desire to shield Paris from an embarrassing procedure. Although Germany is unlikely to face fines under the pact, it could be subjected to the same disciplinary measures the Commission wants to impose on France.

The Chancellor, Mr Gerhard Schröder, and his finance minister, Mr Hans Eichel, are determined to deprive their political opponents of the opportunity to gloat over regular reports and admonishments to the government from Brussels. They are encouraged in their belief that a flexible interpretation of the pact's rules will not harm the euro by the fact that the financial markets appear to be indifferent to the dispute in Brussels.

The markets may not remain unconcerned, however, if it becomes clear there is no political will among EU finance ministers to enforce the pact's terms.

In Frankfurt yesterday, the governing council of the European Central Bank (ECB) described developments surrounding the pact as "critical". The ECB's new President, Mr Jean-Claude Trichet, said the 3 per cent limit on national budget deficits must not be put in doubt.

"Fully abiding by the rules and implementing them in every respect has very solid economic justifications, and is not a mere procedural matter. Upholding trust in the soundness of public finances enhances confidence of all economic agents and thereby contributes to sustainable growth in consumption and investment."

The Commission will shortly seek a compromise with France and Germany that will allow the EU's biggest states to save face while maintaining the authority of the pact.