The dire state of Europe's public finances was laid bare yesterday when it emerged that member states of the European Union may need until 2006 to balance their budgets, two years later than planned.
A report by Mr Pedro Solbes, EU monetary affairs commissioner, painted a picture of sluggish economic recovery and the refusal by some members, including Italy and France, to make the spending cuts necessary to eliminate their deficits.
It is another setback to the credibility of the EU's Stability and Growth Pact, under which EU leaders agreed just three months ago to balance their budgets by 2004.
In a symptom of the crisis, the European Commission revealed that Germany, which invented the pact in the mid-1990s, may itself exceed the deficit limit of 3 per cent of GDP this year.
Yesterday Mr Gerhard Schröder's new government said it would redraft next year's budget in late October or early November to try to find an additional €5 billion-€10 billion of savings. All projects are under review.
Addressing fellow EU commissioners in Strasbourg, Mr Solbes confirmed that EU growth this year would be less than 1 per cent and that the recent deal to eliminate deficits by 2004 was no longer feasible.
He accused some countries - said by Commission officials to include France and Italy - of hiding behind slow growth and of pursuing tax cuts and spending increases in spite of their commitments under the pact.
"The deterioration in the government accounts cannot be entirely explained by the economic cycle," he said.
Portugal, the first country to exceed the 3 per cent deficit ceiling, is facing possible sanctions under the pact, and Mr Solbes said Germany's deficit for this year officially estimated yesterday by Berlin as 2.9 per cent could end up exceeding 3 per cent.
France was "dangerously" close to the 3 per cent limit and will today announce a budget that is expected to run counter to its commitment to a balanced budget in 2004. Italy's deficit is rising along with its national debt.
Although all member states should, in theory, balance their budgets by 2004, Mr Solbes suggested they might be granted until 2006.
The retreat by the Commission was presented as giving the EU breathing space to agree new standards to ensure the pact is respected in future.
Mr Solbes proposed formally monitoring each member state's structural deficit rather than just the nominal figure to take full account of the effect of the cycle on public finances.
France and Italy, both of which are implementing election pledges of tax cuts, are expected to come under particular pressure, and will be told to cut their structural deficit by at least 0.5 per cent a year.
Economists welcomed the Commission's decision to push back the deadline.
The case of Portugal promises to be an important test of national finance ministers' willingness to interfere in each other's budgetary policy. It may also indicate what lies ahead for Ireland should the Government fail to control its finances this year and next.
In July, Portugal submitted figures for its 2001 budget deficit revised upwards from 2.2 per cent to 4.1 per cent of GDP, well above the Stability and Growth Pact's 3 per cent ceiling. The report concluded that the deficit did not result from any unusual event outside Portugal's control, nor from a severe economic downturn.
The pact provides that EU states, acting on a recommendation from the Commission could direct Portugal to take rectifying action and prescribe what that action should be. That would be a highly contentious step, setting a precedent for interference in a member state's budgetary policy.
But Mr Solbes is adamant an excessive deficit should be dealt with "as forcefully and swiftly as possible" - a view the Commission will draft an opinion and recommendation on next month. Finance ministers have agreed they will consider the matter at their November 5th meeting.
- (Additional reporting by Financial Times Service)
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