manny_ramirez
22.03.05, 12:31
Death of a pact: Europe's economies are headed for long-term insolvency.
506 words
22 March 2005
Financial Times
London Ed1
Page 16
English
(c) 2005 The Financial Times Limited. All rights reserved
This March, they came to bury the stability pact, not to praise it - and they
did so with ruthless efficiency.
European finance ministers finally agreed to relax the enforcement procedures
of the pact, which underpins fiscal policy in the European Union. In fact,
they weakened it so fundamentally as to render it practically worthless. The
original idea behind the pact was to ensure long-term sustainability of
public finances in the eurozone. The old pact has failed to achieve this. The
new one does not even try.
Officially, the strict nominal anchors of the pact remain in place, including
the maximum 3 per cent deficit-to-gross domestic product ratio, and the 60
per cent debt-to-GDP ratio. But in reality, the agreement effectively raises
the maximum allowed deficit-to-GDP ratio to at least 3.5 per cent - possibly
close to 4 per cent - depending on how finance ministers define a number that
is still "close to the reference value". "Due consideration" will be given to
three ill-defined spending categories: international aid; European policy
goals; and European unity.
The immediate consequence will be an increase in creative accounting
practices, as member states strive to take advantage of "due consideration"
in case they face an excess deficit procedure. Creative accounting is already
a problem, according to a recent working paper by the Organisation for
Economic Co-operation and Development. With these new rules in place,
governments will be able to run deficits above 3 per cent of GDP for extended
periods without facing an excessive deficit procedure, let alone a financial
penalty.
The compromise will let Gerhard Schroder, the German chancellor, off the
political hook. Germany is now unlikely to face the sanctions procedure
before the 2006 general election. In assessing Germany's fiscal position, the
Commission will take into account expenditure to finance unification and its
net contributions to the EU budget.
The consequences are a deterioration in the eurozone policy mix in the short
run and a rise in public debt in the long run. The European Central Bank
condemned the deal and said it would stick to its targets. This is a thinly
veiled threat to tighten monetary policy in response to a looser fiscal
policy.
What concerns the ECB, but increasingly also international investors, are the
long-term prospects for fiscal sustainability in the eurozone. Standard &
Poor's, the credit ratings agency, noted in a report published this week that
Germany and France would be facing debt-to-GDP ratios of 200 per cent by the
middle of this century, as pension obligations mount on public budgets.
As a result, European institutions and investors should focus far less on the
narrow deficit-to-GDP ratios than on the effective fiscal position, including
contingent liabilities. The problem is not that France, Germany and Italy
have exceeded some arbitrary reference value. It is that, without sharp
corrective action, they are headed for long-term insolvency.
