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Europe high court rules against deficit spending

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EU Governments Broke Budget Law, Highest Court Says (Update2)

July 13 (Bloomberg) -- European Union governments broke the law by suspending the bloc's budget rules last November, allowing Germany and France to keep breaking EU deficit limits without fear of sanctions, Europe's highest court ruled today.

The Court of Justice in Luxembourg, in its first ruling on the ``stability pact,'' annulled ministers' decision to halt the ``excessive deficit procedure'' against Germany and France. Both countries, which make up half the economy of the euro region, have been running deficits in excess of the pact's 3 percent limit since 2002. The court also said ministers have the right to throw out the commission's advice for more spending cuts.

The decision may add impetus to proposals by EU Monetary Affairs Commissioner Joaquin Almunia to revise the way the rules are applied, said Luigi Speranza, an economist at BNP Paribas SA in London. Finance ministers are considering Almunia's plan to give governments more leeway in how and when they reduce deficits.

``The initiatives to modify the stability and growth pact currently under study will probably receive a boost from this ruling,'' Speranza said in a research note. ``It establishes the principle that rules and procedures are binding except under limited and well-defined circumstances.''

The stability pact was designed by Germany before the euro's introduction to protect the currency from government overspending that could fuel inflation. Germany began breaking the rules as the economic slowdown starting in 2001 drove up unemployment and diminished tax revenue. EU policy makers have debated the pact's merits ever since.

New Rulebook

The court's ruling ``draws attention to the problem but doesn't solve it,'' said Julian Callow, Barclays Capital's Chief European Economist in London. ``To recapture that credibility you need a new rulebook.''

Germany and France have fended off a series of reprimands by gaining the backing of other governments in danger of breaking the rules. Six countries -- Italy, the Netherlands, Greece and Portugal, plus Germany and France -- will overstep the limit in 2004, the commission estimates.

``It's good that there is clarity now on procedures,'' said William Lelieveldt, spokesman for Dutch Finance Minister Gerrit Zalm, after the ruling. Zalm, the current chair of EU finance minister meetings, and fellow finance ministers ``will assess the situation and decide what needs to be done.''

List of Setbacks

The November defeat for the commission was the latest in a long line of setbacks for the EU executive, beginning in February 2002 when Pedro Solbes, then Monetary Affairs Commissioner, wanted to issue the first ``warning'' of a deficit offence. Under pressure from German Finance Minister Hans Eichel, finance ministers unanimously rejected Solbes' advice.

Last year, ministers went one step further. As well as ignoring Solbes' calls for more savings in 2004, Italy's finance minister at the time, Giulio Tremonti, proposed suspending further steps towards sanctioning France and Germany.

The commission announced in January that it was contesting the decision in court to gain clarity on how it should discipline nations when they run excessive deficits. Vassilios Skouris, president of the Court of Justice, agreed to handle the case under an accelerated procedure, which means its ruling is made faster than the normal two- to three-year schedule.

Abiding by Procedures

While the court ruled against the suspension of the rules, it also acknowledged ministers' right not to follow commission recommendations for further spending cuts as long as they abide by the procedures set out in the pact.

``This probably means the door is still open for finance ministers to confirm their decision in the substance but they will have to come up with a `legitimate' way round the pact,'' Speranza said.

Almunia, who took over from Solbes as the enforcer of the budget rules, last month said governments should get extra time to cut deficits as long as they have low debt or enact ``structural reforms'' such as selling state assets, fixing pension systems and investing in innovation.

``It's in the commission's interest that there is political ownership of the stability pact,'' said Katinka Barysch, chief economist at the London-based Center for European Reform, a research institute.

The European Central Bank is also pressuring governments to cut their deficits to keep interest rates down. Earlier this month, ECB policy makers decided to keep its main lending rate at a six-decade low of 2 percent, declining to follow the U.S. Federal Reserve's quarter-point increase, as growth in Europe lags the U.S.

Lagging Growth

The commission foresees an expansion of 1.7 percent in the euro region this year, trailing rates of 4.2 percent in the U.S. and 3.4 percent in Japan.

Debate on how to follow the rules could stretch into next year, according to Zalm. Any formal changes to the pact would require the approval of all 25 EU governments, and is therefore unlikely, he said in an interview June 29.

Almunia's backing for a more flexible enforcement of the fiscal framework may rankle the Netherlands, which together with Spain, Austria and Finland, opposed letting France and Germany off the hook last year.

``The longer finance ministers go on without a clear set of rules, the more you run the risk of what I would call fiscal debauchery,'' said Callow. ``Since last Autumn, the fiscal situation has worsened notably for the euro area as a whole and the three biggest economies in particular.''

The case is C-27/04 Commission v Council.

Last Updated: July 13, 2004 05:23 EDT

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