Commission suggests EMU public debt rule ‘superfluous’

Date: 08/02/1996

By Tim Jones

BELGIUM and Italy could see their journey to a single currency bloc eased if a proposal to turn a blind eye to the Maastricht Treaty's public debt target is agreed by member states.

As German politicians repeat their demand for a strict interpretation of the treaty's infamous 'convergence criteria', the European Commission is suggesting that capping public debt at 50&percent; or 60&percent; of gross domestic product (GDP) in the 'Euro' bloc would be a waste of time.

In a discussion paper aimed at incorporating the German idea of a 'stability pact' into a Union framework, the Commission services conclude that targeting the budget deficit at 3&percent; of GDP and, in the longer-term at 1&percent;, is far more important.

“Seeking to impose an additional constraint on the gross debt ratio appears to be superfluous, as permanently keeping the deficit below 3&percent; of GDP would ensure a downward trend in the debt ratio to well below 60&percent; of GDP,” says the report.

While the proposals relate to the conduct of fiscal policy within the single currency bloc once it has been established, they are music to the ears of the Belgian authorities.

They feel their country's low inflation and interest rates, huge trade surplus and steadily reducing budget deficit will qualify Belgium for the first-tier of monetary union membership, even if poor economic management in the Seventies has left it with public debt worth close to 140&percent; of GDP.

“In 1996, Belgium will fulfil four out of the five criteria with honour,” said National Bank President Alfons Verplaetse in October.

“The fifth criterion, that is the Belgian debt level, is a reminder of what went wrong in the past, rather than an indicator of present policy performances.”

The slowdown in economic growth throughout Europe at the end of last year means that the government will probably miss its budget deficit target of 3&percent; of GDP this year, but should be able to achieve it in 1997.

When a summit decides in early 1998 who should join the monetary union, Belgium should have satisfied every criterion and the political imperative to bring the whole of Benelux into the bloc will be great.

The only questionmark will hang over whether, in the words of the treaty, Belgium has cut its public debt ratio at a 'satisfactory pace', even if it still close to 130&percent; and has no chance of cutting it to 60&percent; before 2015.

The Commission report holds out fresh hope for Brussels. It says that sustaining a 1&percent; budget deficit, as the Germans demand, would require a primary surplus - with government revenue outstripping spending once interest repayments on old debts have been taken out of the equation - of between 5.5&percent; and 7&percent;. This should allow the debt to fall ten percentage points over a decade.

Belgium's primary surplus has grown steadily in the Nineties and the government is aiming to keep it around 6&percent; in the coming years, allowing significant reductions in the overall deficit and the debt.

While Italy's prospects for monetary union membership are less rosy, given continued political volatility and the absolute size of its public debt (which now represents 124&percent; of GDP), it too will benefit if the Commission's arguments are taken up.

With a primary surplus of 3&percent;, sustained budgetary cutbacks and one of the EU's better growth rates, Italy is on course to hit the 3&percent; deficit target in 1998, a year too late.

“Italy could join, but it depends how flexibly you look at the Maastricht Treaty, whether you are prepared to look behind the figures and realise Italy is not in a debt trap anymore,” said Giorgio Raedelli at Lehman Brothers International.

Over the last two years, Italian governments have succeeded in reining back public spending despite unrelenting political pressure. If new Prime Minister-designate Antonio Maccanico can form a government capable of sustaining the Italian parliament's support, he may be able to take even tougher measures.

Many German and French companies, if not their central bankers, would be keen to lock Italy into a single currency rather than leave it outside as a constant devaluing threat. Whether Bonn and Frankfurt can agree to this is, however, another matter.