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Wednesday, February 19, 2003

More Argy-Bargy Looming in Euroland

The eurozone never did promise to be a quiet place. First there was all the criticism of the ECB as an 'anti-growth' institution, then there were Prodi's 'stupid' stability pact remarks, now it's the turn of Solbes's deficit-relaxation proposals, with the UK serving as the whipping boy. The problem this time is that with weakening economic growth, UK Chancellor Gordon Brown's for a major investment programme in schools, hospitals and transport, have led to a significant rise in Britain's budget deficit. Brown defends the rise by arguing that Britain should be allowed to run small deficits in the medium term because its public finances are strong, with low levels of national debt and minimal pensions liabilities. Here he is backed by EU Commissioner Pedro Solbes who thinks the stability pact should be relaxed to allow those with a relatively sound underlying financial position should be able to increase the deficit in times of low, or negative, growth. This 'licence' to create medium term deficits understandably irks those who have struggled to comply with the more rigid interpretation of the pact, hence all the fuss. The trouble is that with all the underlying friction floating around over the Iraq war issue it's hard to see any of these issues having a smooth ride, and without a smooth ride anti-euro sentiment in the UK can only rise. It's difficult to see either Gordon 'five-test' Brown, or Mervyn King giving the thimbs up to euro entry, but don't miss the poll result at the end of the article: 35% of voters now favour entry.

As Gordon Brown sped away from the meeting of European finance ministers in Brussels on Tuesday, his officials shied away from claiming victory, but at least suggested that the result was at least not as bad as it could have been. One called it "a satisfactory outcome". But the call by the Ecofin council for Britain to aim for a budget that is "close to balance" creates problems both for the chancellor's reputation for prudence, and for Britain's chances of joining the euro in the near future. Mr Brown's success, such as it was, was that the meeting did not conclude explicitly that Britain was in breach of the stability and growth pact, the set of rules intended to restrict borrowing by European Union member governments. Most countries rejected a statement backed by Denmark, Belgium and Spain that Mr Brown's planned deficits were "significantly above the close-to-balance position required by the stability and growth pact". But the agreed statement took a tougher line than the European Commission's view this month. In particular, it recommended that "the UK authorities should aim for a medium-term budgetary position that is in line with the 'close-to-balance' requirement" of the pact. The EU has in the past defined "close to balance" as meaning a deficit of no more than 0.5 per cent of gross domestic product. Mr Brown plans to borrow 1.5 per cent of GDP in five years' time. The implication is that he must cut public spending or put up taxes by 1 per cent of GDP - worth about £10bn at today's prices - to deliver the recommendation. The tax rise would be the equivalent of about 3p on the basic rate of income tax.

The doubt cast on Mr Brown's plans is an embarrassment for the chancellor, and would be a greater em- barrassment should Britain try to join the euro. Philippe Legrain, chief economist of Britain in Europe, the pro-euro group, pointed out that there was no penalty for failure to comply with the recommendation. "There's no need for Gordon Brown to change his spending plans as a result of anything the council said, whether or not Britain joins the euro," he said. But the statement, which is similar to the opinion of Mr Brown's plans delivered last year, suggests that despite talk about reform of the pact, the British interpretation of the rules is not generally accepted. A potentially bigger worry for Mr Brown is the requirement that government borrowing should be kept below 3 per cent of GDP: a limit backed up with fines for countries inside the eurozone. "I expect a deficit of 2.7 per cent of GDP next year. Allowing for the normal margin of error of plus or minus 1 per cent, a breach of 3 per cent is certainly possible," said John Hawksworth, of PwC. "It would be a very difficult time to join the euro if the government was trying to win a referendum at the same time as being threatened with sanctions."

Countries such as Germany and France, which have tacitly supported Mr Brown, have both fallen foul of the EU's deficit rules but are pushing for more flexibility in the application of the pact's 3 per cent limit. But the result is more confusion about what the rules would mean for Britain. As Mervyn King, who is to take over as governor of the Bank of England, put it: "If you can explain to me in detail precisely what the stability and growth pact is now, then I might find it easier to answer on that, but I'm not entirely sure what status it is now." That confusions looks like one more reason why the assessment of the euro tests will conclude they have not yet been passed. A poll for Barclays Capital has found 48 per cent of people said that if the government said the five tests had been passed, they would still vote against euro entry; only 35 per cent said they would vote in favour. Adam Law, of Barclays Capital, said: "It's a sensible inference that people are less trusting of the government's policies, given their concern over Iraq."
Source: Financial Times

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