Shedding the fat and keeping it off

Date: 28/11/1996

ANYONE who has tried to lose weight can testify that shedding the fat is the easy bit. Keeping it off is the real test of resolve.

So it is for those bidding to join the single currency bloc. It has already proved politically difficult - almost suicidal in some cases - for governments to introduce the public-spending cuts and tax increases needed to meet EMU entry criteria. Once that is done, how will the custodians of the new currency ensure its members hang on to their new-found budgetary discipline?

Last year, as the popularity of the euro project started to decline in Germany and the business establishment began to fret over how reformed 'fatties' would behave once inside the currency zone, Finance Minister Theo Waigel hit on an idea.

He decided to propose the formation of a new 'stability pact' to speak where the Maastricht Treaty was silent, setting budgetary targets and deadlines for those inside the EMU zone as well as sanctions for non-compliance.

Footnotes of the pact are still to be hammered out, but the thrust of an extraordinarily tough fiscal arrangement has already been agreed. Once inside EMU, member states will have to keep their budget deficits below 3&percent; of gross domestic product and preferably close to balance in boom years.

In 1998, even before EMU is up and running, the finance minister of each country in the first wave of entrants will have to submit a 'stability programme' to the European Commission and other members. This will incorporate their aims for the budget surplus/deficit as a ratio to GDP and predictions of how quickly the ratio of public-sector debt to GDP will fall in each of the following three years. It will also include assumptions about economic growth, unemployment, inflation and trade balances, proposed measures for meeting the objectives and automatic corrective measures if they are missed.

This exercise will have to be repeated every year, no later than two months after the presentation of annual budget proposals.

The programme will be scrutinised by the Commission and the EU's economic and financial committee (which will replace the monetary committee once EMU begins) to see whether

the targets are sufficiently ambitious or over-optimistic, and whether the proposed measures are tough enough to correct overshoots.

Within two months, a mini-Council of finance ministers of countries in the bloc will either endorse or reject the programme.

Implementation of each member state's programme will be watched for signs of divergence from its medium-term objectives. If a member state does slip up, the mini-Council “shall in general” recommend spending cuts or tax increases to correct it.

If this 'early warning system' does not work, it could start to get nasty. Within three months of a government submitting its financial records to the Commission in March, ministers will decide whether a member state has an “excessive deficit” - bearing in mind whether “exceptional” and “temporary” events have caused it. (Bonn is still trying to define these circumstances as a severe recession measured as negative growth of 2&percent; over four consecutive quarters, but has yet to win the agreement of other member states to this.)

The mini-Council will then have four months to decide whether the errant member state has taken adequate corrective measures. If it decides they are insufficient, ministers must vote within two months on whether to force the member state to place a large non-interest-bearing deposit with the Commission.

This deposit will be calculated with two components: a fixed amount of 0.2&percent; of the country's GDP, plus a variable element equal to a tenth of the amount by which the deficit overshoots the 3&percent; target. (The Commission wants to cap fines at 0.5&percent; of GDP while Germany believes there should be no ceiling.)

This deposit will be converted into a fine if the excessive deficit has still not been corrected after two years.

Governments which remain outside EMU will not get off scot-free. Although free to choose whether or not to join the revamped Exchange Rate Mechanism, now known as ERM II, most will want to sign up in order to prove their worthiness for membership of the euro bloc at the second time of asking.

Their currencies will be pegged against the euro and allowed to fluctuate 15&percent; either side of a central rate while some, such as the Danes, are sure to be allowed a tighter band.

Countries in the euro waiting room will also be expected to submit 'convergence programmes' with the same detail and subject to the same scrutiny as those bound by the stability pact. If they fail to stick to these measures, the European Central Bank will be within its rights to suspend intervention in the foreign exchange markets in support of the currency of the country concerned.