Financial wizards conjure up a political storm

Date: 01/05/1997

THE monastic world of the economist has never experienced anything quite like it.

It is usually civil wars which are the subject of telephone and shuttle diplomacy, ministerial assignations in corridors, press campaigns and presidential condemnations.

But, this time, it was the skill with a calculator of a small group of number-crunchers within the European Commission's economic forecasting service which inspired all this sound and fury.

It is hardly surprising. When Economics Commissioner Yves-Thibault de Silguy announced last week that the Italian budget deficit was unlikely to fall below the single currency membership target of 3&percent; of gross domestic product, he must have expected a storm.

Dropping this bombshell while giving France, Germany and 11 other EU member states a clean bill of budgetary health was guaranteed to whip up a political tempest.

Italian Prime Minister Romano Prodi has invested everything in taking his country into economic and monetary union when it kicks off in January 1999.

Learning from the Commission that they are not going to make it on current policies was a shock to the Italians. After all, it will be the Commission which assesses each country's EMU-readiness next spring on the basis of its 1997-98 budgets.

Rumours started to spread of a stitch-up. The forecasts were, it was said, part of a grand German plan hatched at the recent informal meeting of finance ministers in Noordwijk to keep Italy out of the first wave. The supposedly impartial economists had been nobbled.

But, in fact, the behind-closed-doors story underlying this year's forecasting circus is much more prosaic.

Staff at the Directorate-General for economic and financial affairs (DGII) knew they had to get working on their annual spring forecasts early this year. The scheduling of the Amsterdam summit in mid- rather than late-June meant that this year's broad guidelines for economic policy, which always contain the latest forecasts, had to be written early.

For this reason, Deputy Director-General Heinrich Matthes convened staff in late February for the traditional kick-off meeting of the forecasting round. This gathering always settles the key external elements - the expected exchange rate of the US dollar and the growth of world trade, as well as the direction of interest rates - which help to determine economic growth, inflation, trade flows and tax revenues.

Taking the lead were Directorate C (surveillance of the EU economy) under Ludwig Schubert and Directorate A (national economies) under Antonio José Cabral, backed up by Directorate D (monetary matters) and Directorate F (international affairs).

The half-day meeting took two crucial decisions. Officials decided to work on the assumption that the average rate of the dollar this year would be 1.70 deutschemark rather than the 1.50 factored into their autumn 1996 forecasts, and they plumped for 7.2&percent; growth in world trade.

With the meeting out of the way, national desk officers were told to go back to their offices and complete their preliminary forecasts by 11 March, while Directorate F staff got to work on their predictions for the US, Japanese and eastern European economies. In all, about 40 staffers were involved.

All the time, a 'synthesis' team checked the work for consistency - assessing, for example, whether total intra-EU imports and exports matched up as they logically should.

Once the draft forecasts were finished and had been run through the Commission's econometric model, bilateral talks began between DGII and forecasting experts back in national capitals. It was at this point that the leaks began. On 10 April, a Portuguese daily published a table of forecasts which startlingly included an expected budget deficit of 3.2&percent; for Germany and 3.8&percent; for Italy.

The bilateral talks culminated in a two-day meeting between DGII forecasters and national experts at the Commission's Albert Borschette building in Brussels; a place best known as the venue for meetings of the secretive monetary committee.

Commission economists arrived already prepared to reduce their deficit forecast for Italy given that the Prodi government had announced supplementary savings worth 8 billion ecu a week earlier. Needless to say, the Italian representatives came with data showing how they would hit 3&percent; of GDP this year.

The Commission team cut its forecast, but could not get it below 3.2&percent; for 1997 and - even more importantly - actually found the deficit would rise to 3.9&percent; of GDP in 1998 if no extra measures were introduced. Prodi and his Treasury Minister Carlo Azeglio Ciampi had used too many one-off measures in their budgets to make this avoidable.

The German delegation achieved a better result. DGII had expected the German deficit to be slightly above 3.0&percent; this year until Bonn officials came to the meeting with more information about extra anticipated revenue in the social security budget. Both sides agreed that it was too early to judge how strong tax revenues for the whole year would be.

The Monday after the meeting, Ciampi began his campaign to convince the Commission to think again by seeking out De Silguy at the annual meeting of the European Bank for Reconstruction and Development in London. The Commissioner then left London for Frankfurt, where he briefed the European Monetary Institute's council on his staff's findings.

It was not until a meeting of the Commissioners' chefs de cabinets on 17 April that the real pressure began. DGII had deliberately opted not to pass the forecasts around among the chiefs of staff in case they leaked. However, they did circulate papers to prepare the broad economic guidelines and these included the 1997 budgetary forecasts.

For Italy, the deficit was 3.2&percent;. Rome was contacted. By the weekend, Prodi and Ciampi were on the phone to Italian Commissioners Mario Monti and Emma Bonino in an attempt to notch down the forecast by 0.2&percent; of GDP.

Monti was not fertile ground. It was not long ago that the professor of economics was lecturing his government first about its reluctance to try to hit 3&percent; of GDP in 1997 and then about the 'Euro-tax' scam designed solely to meet the target this year at the expense of subsequent budgets.

But he was nevertheless concerned that while the forecasts might show an overshoot, the Herculean efforts made by the Italians in reducing last year's 6.7&percent; deficit to close to 3&percent; this year should be recognised.

After talks with De Silguy, it was agreed that a footnote should be added to the forecast table to the effect that “this may become 3&percent; of GDP ... if the measures already taken have full effectiveness and, if necessary, additional measures are introduced”.

Bonino, on the other hand, took the call to arms very seriously. By Monday 21 April, she was lashing out at “unbalanced” forecasts which favoured Paris and Bonn over Rome and promising a “battle” to put the figures right.

Meanwhile, back at DGII, economists were putting the final touches to the forecasts. They were completed on Tuesday and printed on Wednesday just in time for circulation at the weekly meeting of the 20 Commissioners.

A political agreement had already been reached behind the scenes, but Bonino wanted her day in court.

As she began her speech, journalists were gathering outside the door of De Silguy's spokesman Patrick Child downstairs on the sixth floor of the Commission's Breydel building. Impatient reporters from financial wire services, who had been promised the figures under embargo at 10.15am, were getting worried as the clock ticked towards 11.30am.

Back upstairs, Bonino rehashed her arguments from Monday. She cried foul about political favouritism and even suggested the forecasts should not be published. De Silguy asked his Italian Director-General Giovanni Ravasio to explain how the figures had been drawn up and allay Bonino's fears.

Finally, the Commissioners agreed to release the figures, but not as a document sanctioned by them all.

Child returned to his office and was swamped by financial reporters desperate to get the news out first. It was midday. There followed a savaging for De Silguy first by some members of the European Parliament's monetary policy oversight committee and then by the Brussels press corps.

He had better get used to it. This year's fiasco was nothing compared to what will happen next spring when the final decision is taken as to who is and who is not eligible for EMU.