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Cablegate: The Eu Stability and Growth Pact: Dead, On Ice, It

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 07 FRANKFURT 009824

SIPDIS

STATE FOR EUR PDAS RIES, EB, EUR/AGS, AND EUR/ERA
STATE PASS FEDERAL RESERVE BOARD
STATE PASS NSC
TREASURY FOR DAS SOBEL
TREASURY ALSO FOR ICN COX, STUART
PARIS ALSO FOR OECD
TREASURY FOR OCC RUTLEDGE, MCMAHON

E.O. 12958: N/A
TAGS: ECON EFIN EUN
SUBJECT: The EU Stability and Growth Pact: Dead, On Ice, It
Lives; Form Over Substance?


T-IA-F-03-0062

REF: (A) Frankfurt 08852; (B) Berlin 4399; (C) Paris 8585;
(D) Paris 8620

(1) (SBU) Summary: The failure of EU Finance Ministers to
find a compromise on November 25 acceptable to all on the
treatment of Germany and France under the Stability and
Growth Pact (SGP) sent another negative signal on the
viability of rules to coordinate fiscal policy in a monetary
union without political union. The European Central Bank
(ECB)'s statement that Econfin's conclusions "carry serious
dangers" is a reflection of their concern that one of the
institutional underpinnings of the European Monetary Union
has been weakened.

(2) (SBU) A close reading of Ecofin's conclusions suggests
that the disagreements were more over process than
substance. Fundamentally, the issue was who is responsible
for fiscal policy coordination, member states or the
European Commission? By rejecting the Commission's
recommendations, the Council sent a clear message: it's the
member states. Failure to find common ground between all
member states and the Commission on such an important, high
profile issue could be a set back for the cooperative spirit
necessary for SGP rules to be effective.

(3) (SBU) On substance, the qualified majority of Ministers
agreed that Germany and France should correct their
excessive deficits by 2005 rather than 2004, given the weak
economic recovery. The Commission had come to the same
conclusion. However, the Commission had recommended that
France and Germany (a) be found not to have complied with
Ecofin's earlier recommendations (reftels); and (b) be
notched up on the SGP's disciplinary rack, to just under the
sanctions rung. In so doing, the next time these countries
were found not in compliance with the Ecofin's
recommendations, they could face sanctions. In this way,
the Commission sought to bring along the hard-line, smaller
countries that were disgruntled with giving the next year
for Germany and France to get their budgets in shape. This
procedure proved to be the undoing of any compromise.

(4) (SBU) German Finance Minister Eichel took the lead in
opposing the Commission's proposal, not wanting to appear to
be "punished" (a German Finance Ministry characterization)
for doing the "right thing," particularly at a time when he
is facing tough domestic budget battles with the opposition
and his own party. France was comfortable riding in
Germany's draft, calculatedly showing signs of "flexibility"
that, in the end, would be meaningless given Germany's tough
stance.

(5) (SBU) While seemingly orthodox on substance but off the
consensus line on process, different portrayals of the SGP
have been rendered: it is variously dead, on ice, or lives.
The consequences of failure to reach unanimous agreement,
however, could be serious -- not immediately for financial
markets, but for the future. Other instances of this
inability of member states or the Commission to find common
ground in the economic world have cropped up under the
Italian Presidency (Investment Services Directive, Takeover
Directive) and could well spill over into other areas such
as the drafting of the Constitutional Treaty for Europe.
While one or two disputes might not send a signal to
financial markets, the inability to shape a more workable
Europe could. End Summary

The Setting and Conclusions of November 25: Just the
Facts
--------------------------------------------- ------------
-

(6) (SBU) Earlier this year Ecofin had declared that France
and Germany have deficits that exceed the 3% of GDP
reference value in the EU Treaty and would be handled under
the SGP's "excessive deficit procedures." On October 8 the
EC had recommended, in accordance with Article 104(8) of the
Treaty, that France had taken no effective action to
implement Ecofin's June recommendations to correct its
excessive deficit. On October 21 the Commission further
recommended that France take further measures to reduce its
deficit and that it submit implementation reports every six
months over the next two years so the Commission and Council
could assess progress. The recommendation was under Article
104(9), the last step before moving to possible sanctions if
France were to fail to comply with the new recommendations.
Finally, the Commission gave France an extra year, to 2005,
to correct its deficit.

(7) (SBU) The Commission's autumn forecast showed that
Germany also would fail to reduce its deficit below the 3%
of GDP reference value in 2004. On November 18 the
Commission drafted similar recommendations for Germany under
Articles 104(8) and 104(9).

(8) (SBU) At their November 25 session there was no
qualified majority of the Ecofin to accept the EC's
recommendations on France and Germany (reftels and USEU
septel). Denmark, Spain, Belgium, Sweden, Austria, the
Netherlands, Finland and Greece voted for the Commission's
recommendation that both countries had taken no effective
action to correct their deficits. The same countries voted
for the Commission's recommendations under 104(9), except
Denmark and Sweden who, because they have not adopted the
euro, cannot vote on decisions under Article 104(9).

(9) (SBU) A qualified majority was mustered for an
alternative conclusion, described below. Backing the
alternative approach on France was Germany, Italy, Greece,
Belgium, Portugal, Luxembourg and Ireland. The same group,
but substituting France for Germany (since the country
subject to the procedures cannot vote on its own case),
voted for similar conclusions on Germany.

(10) (SBU) The Commission recorded its position in Ecofin's
report of its meeting by noting that Ecofin's rejection of
the Commission's recommendation was without any explanation,
as required in the SGP, and by stating that Ecofin's earlier
recommendation - which was a "decision" -- is still in force
(that calls for deficits to be under 3% in 2004). The
Commission declared that it regretted that the "spirit and
rules" of the SGP were not followed and reserved "the right
to examine the implications of the Council conclusions and
decide on possible subsequent actions."

Ecofin's Alternative: Broad Agreement with the Commission
on Substance
--------------------------------------------- ------------
-------------

(11) (SBU) On substance, Ecofin's conclusions were broadly
similar to the Commission's recommendations. These call for
(a) an end to excessive deficits "as rapidly as possible and
at the latest 2005;" (b) structural reforms recommended in
the EU's Broad Economic Policy Guidelines to be reflected in
implementing measures to reduce the deficits; and (c) an
acceleration of the reduction in the cyclically adjusted
deficits should the recovery be stronger than currently
expected. The Commission wanted any higher-than-projected
revenues to be allocated to deficit reduction, while Ecofin
agreed to do so only if growth were higher than expected.

(12) (SBU) Slight differences in the speed of structural
deficit adjustment in 2004 appear between the two texts.
Ecofin called for 0.6 percentage point reduction in Germany
compared with the Commission's 0.8. For France Ecofin asked
for 0.8 percentage point reduction, rather than 1.0 sought
by the Commission.

Econfin's Alternative: Major Difference on Procedures
--------------------------------------------- --------

(13) (SBU) The fundamental difference between Ecofin's and
the Commission`s approach was on process. Ecofin did not act
on the basis of Treaty Article 104(9) as proposed by the
Commission. Under this Article, if a member state "persists
in failing to put into practice the recommendations of the
Council may decide to give notice to the Member State to
take, within a specified time-limit, measures for the
deficit reduction.. And can request reports in accordance
with a specific timetable to "examine the adjustment
efforts." Instead, Ecofin just issued more recommendations,
an iteration of their earlier action under Article 104(7).
The difference is that failing to comply with
recommendations under 104(9) would mean that the next stop
would be sanctions.

(14) (SBU) In addition, Ecofin called for "biannual
notifications" on progress in fulfilling their commitments
with the Commission and Council to give "due attention to
prevailing economic conditions and the structural reforms
being implemented." The Commission had recommended four
"implementation reports" over the next two years to assess
progress.

Germany: Takes the Lead - France in its Draft
---------------------------------------------

(15) (SBU) Germany would not accept being subjected to a
recommendation under Article 104(9), full stop. According
to a Commission official, this was the fundamental stumbling
block. The German delegation could agree to many
formulations, but none that included Article 104(9). One
formulation sought to give Germany assurances that a
recommendation under 104(9) would not lead automatically to
sanctions if Germany were doing its best to reduce the
deficit. No dice.

(16) (SBU) The German position, according to several German
Finance Ministry officials, was driven by their view that
they had lived up to Ecofin's recommendations issued to
Germany in February. The Commission had confirmed that when
they assessed Germany's policies in May (ref a and b).
Deterioration in Germany's 2003 structural budget position,
as highlighted in the Commission's new autumn forecast, was
a reflection of other changed circumstances, not a change in
Germany's budget policies. Specifically, German Finance
Ministry experts point that that revisions of the
statistical series, lower inflation (meaning lower revenues
than budgeted), and the Commission's assumption of lower
potential output all conspired to increase Germany's
structural deficit.

(17) (SBU) The Commission's recommendation to reduce the
structural deficit by an additional 0.2 percentage points to
0.8 was unappreciated. The government is still uncertain of
getting its budget and reform package adopted that would
cause an estimated 0.6 percentage point reduction already
programmed into the Commission's calculations. According to
a German Finance Ministry, the Commission said it was trying
to help Finance Minister Eichel in his tough budget debates.
With the final shape of the package in flux, the Commission
thought now was a good time to up the ante. From the
Ministry's viewpoint, the Commission's meddling came at a
particularly bad time in the domestic political debate.
Despite having taken tough, unpopular measures in 2003, the
Commission's move to Article 104(8) and 104(9) was being
construed as "punishment," in the words of one German
official, for "doing the right thing." It was asserting
that Germany had taken no measures and was being put on
formal legal notice of defaulting on its obligations. "This
is ridiculous; the Minister will not accept it."

Buddy System: Two Sink or Two Swim?
------------------------------------

(18) (SBU) German Finance Ministry officials were also
irritated that their case was being put together with that
of the French. In their view, France had been disdainful of
SGP procedures. German Finance Ministry officials explained
that they had privately been working with French finance
officials, coaxing them to take additional budget
consolidation measures. That seemed to be working, in their
view. France had announced a 0.1 percentage point
additional cut to their structural deficit for 2004. The
SGP was exerting pressure and "working" in their assessment.

(19) (SBU) The Commission's case on Germany was issued on
November 18 and put on the November 25 Ecofin agenda
together with the French case, the discussion of which had
been postponed from the November 4 Ecofin meeting. Why not
postpone discussion on the German case, pleading the need
for more time, thus de-linking the substantive debate on the
two?

(20) (SBU) One German Finance Ministry official said "there
is a certain dynamic" between Germany and France that made
the linkage inevitable. Another was resigned that a fight
was inevitable, so postponement "won't help." The
Commission logic, according to an official close to the
process, was the assumption that Germany would not vote on
the merits of the French case, rather would be driven by
politics. Despite their private displeasure with the
French, the Germans would support them in a vote.

(21) (SBU) Also, the French had insisted on equal treatment
with Germany. The Commission's recommendations on Germany
were virtually identical to those for France, a point the
Commission recorded in its press release. An ECB official
pointed out that while the German rhetoric had been positive
toward the SGP, the numbers looked about the same. Germany
had not reduced its structural deficit as it had pledged -
although not because of the central government's policies.

(22) (SBU) Twinning benefited France. According to a
Commission official, Germany did most of the talking.
France demonstrated some flexibility, but maybe, mused this
official, because they knew it would not be taken up given
Germany's immoveable position on Article 104(9).

(23) (SBU) French Finance Minister Mer could never have
accepted a recommendation under Article 104(9) directed at
France alone. While Germany might technically have asked
for a final delay to December 12 in Ecofin consideration of
its respect for the Commission's recommendations, France had
no more room for maneuver. Mer went into the Euro Group
meeting having signaled to the press that the GOF would
bring flexibility to the table, but all indications are that
he had no mandate to accept the Commission's recommendation
of a 1%-of-GDP cut in the 2004 structural deficit. Thus he
could stand shoulder to shoulder with Eichel (or perhaps,
back to back) in an absolute rejection of a recommendation
uner Article 104(9).

(24) (SBU) Despite Italian Finance Minister Tremonti's
claims just a few weeks that SGP targets should be upheld,
his reversal to support the Germans and French is not
surprising. Tremonti has often expressed his concern that
the SGP does not encourage economic growth - and in country
with the lowest growth rates in the EU, this concern
resonates particularly well. The Italian Government also
realizes that it could be well be standing in German shoes
next year; even under the most optimistic economic
predictions, Italy in 2004 will likely be hovering around
the three percent deficit ratio. Self-interest rather than
esprit de corps with the French and Germans prompted
Tremonti's "change of heart."

The Commission: Rejected Again -- Principles and
Practicalities
--------------------------------------------- ------------
------

(25) (SBU) The Commission wrapped its position in principle.
In explaining the decision to the European Parliament in
Strasbourg on November 18, Commissioner Solbes declared that
"The College stood firmly by the principle that we are a
Community of law and that the Treaty and the Stability and
Growth Pact have to be applied together." While Germany had
taken budget consolidation measures in 2003, it is in "non-
compliance" with the Council recommendation to end its
excessive deficit situation in 2004. Therefore the
Commission has an obligation to inform the Council of this
fact and "recommend further steps to be taken according to
Article 104(9)."
(26) (SBU) The Germans argued that the Commission took a
"mechanistic" approach. First, the Commission could not
assert that Germany had taken "on effective action," since,
as noted above, the Commission had signed off Germany's
package as recently as May. Second, even if the actions
were inadequate, there is nothing in the Pact or the Treaty
to suggest a country should be immediately treated under
104(9), in their view. A German Finance Ministry official
reports that the Council's legal services shared this view -
at odds with the Commission's legal services. Ecofin's
approach, in the view of theis official, was to "update" the
earlier recommendations in light of changed circumstances
since Germany has complied with the recommendations but the
deficit failed to respond.

(27) (SBU) By using Article 104(9), the last stop before
landing on the possibility of sanctions, the Commission
sought to increase pressure on Germany and France, thereby
seeking to appease the hard-line countries who were
disgruntled that the Commission had given both countries the
extra year to correct their excessive deficits. According
to a Commission official, the smaller countries would have
accepted the Commission's compromise. Excluding action
under 104(9) meant no compromise. And so it was.

(28) (SBU) A neater legal solution would have been for the
Commission to see which way the wind was blowing then, with
the appropriate concessions to save its face, proposed
revised recommendations based on the approach favored by the
qualified majority. The Commission, according to this
German official, knew it did not have the votes on France as
early as the first week in November. Not heeding the
warning signs, the Commission barreled along, putting the
German case on the table as well. The Commission, in this
official's view, was heading for failure. In the
negotiations the Commission demonstrated flexibility on
substance, but not on process. In the end, the Commission's
decision to stick to their guns was not Commissioner Solbes
decision to make, according to this official, but left to
the President of the Commission.

ECB: "Serious Dangers"
------------------------

(29) (SBU) The ECB had been concerned about the debate and
had weighed in on the side of the Commission's compromise.
In its November Monthly Bulletin the ECB reported that the
"Governing Council takes the view that the proposals of the
Commission push the room for interpretation of the rules and
procedures to the limit." A senior ECB official repeated
this statement when asked the ECB's view on the Commission
compromise.

(30) (SBU) In his first major policy speech on November 20,
ECB President Trichet made an impassioned plea: " I very
profoundly wish an hope that all partners concerned will, in
the coming days, live up to their responsibilities: The
Commission, the Council, the governments concerned, so that
we can not only preserve but reinforce the overall
credibility of the euro area, and therefore growth."
Trichet and Vice President Papademous participated in
Ecofin's all night discussions on November 24 that ran until
4:30 am.

(31) (SBU) Following Ecofin's conclusions, the ECB's
extraordinary press release declared that the Governing
Council "deeply regrets these developments and shares the
views of the Commission on the Ecofin Council conclusions.
The Conclusions adopted by the Ecofin Council carry serious
dangers. The failure to go along with the rules and
procedures foreseen in the Stability and Growth Pact risks
undermining the credibility of the institutional framework
and the confidence in sound public finances of Member States
across the euro area." This is "serious," in the words of
an ECB official.

A Word From the Market
----------------------

(32) (SBU) As confirmed by an ECB official, the decision had
no effect on the market. However, one currency strategist
said if this disagreement were to lead to a break-down of
the Inter Governmental Conference, such a break down would
send negative signals to investors about the euro. Ecofin's
decisions could have implications for the IGC's negotiations
on a Constitutional Treaty for Europe, potentially making
agreement more difficult rather than less.

Two Observations: Deeper Meaning of the Pact
--------------------------------------------

(33) (SBU) As a comment, we limit ourselves to two
observations, one on the operation of the SGP, the other on
the potential deeper implications.

(34) (SBU) With respect to the operation of the SGP, it has
been variously described as "dead," (Financial Times),"on
ice" (Dutch Prime Minister) and "living" (German Finance
Minister Eichel). We discount the FT's view since they are
generally negative on the SGP in principle (although they
have softened of late - agreeing on the need for rules to
coordinate fiscal policy in the monetary union). The FT's
ability to generate so many stories on a "dead" agreement
suggests the SGP has more lives than the proverbial cats'
nine.

(35) (SBU) The Dutch have a point, but one enshrined in the
SGP. If countries fulfill Ecofin's recommendations, then
the excessive deficit procedures are considered to be in
abeyance. Ecofin made that explicit in its conclusions.

(36) (SBU) Eichel too has a point. The SGP continues to
exert peer pressure and is taken seriously, very seriously
in Germany. Over the November 28-29 weekend German Finance
Ministry officials conveyed their views to the press that
the SGP included the necessary flexibility to accommodate
the current economic situation. Perhaps this could explain
why Eichel reacted so strongly. Entrenched in a political
battle not only with the opposition but also his own party
for his budget stewardship. After using the SGP to help
justify his own predeliction for subsidy cuts and keeping
deficits as low as possible, to be seen as "punished" by the
SGP procedures would be a political cut of the deepest sort.
Groused one Finance Ministry official - "the SGP means
nothing to the French population - in Germany it does." The
irony of Germany's position in the SGP continues to
compound: the principal author, one of the first test cases,
now running interference for the French. Eichel is playing
a high stakes game domestically that has washed over to the
EU level - increasing the stakes considerably.

(37) (SBU) The second observation is on the deeper meaning
of Ecofin's decision. One reason to be concerned with the
outcome is the failure to find a compromise that was
acceptable to all. The SGP is more than rules. It is
almost a state of mind, of the individual members reflected
the broad good of the whole - being communautaire.
Coordination of fiscal policy in a single monetary union is
a cooperative exercise, depending upon compliance with rules
- not enforcement.

(38) (SBU) A key to moving forward is to recapture that
cooperative spirit. Pursuing the issue in courts is a
questionable tactic to foster cooperation. Moreover, it
implies that the SGP is a precise legal covenant. The
Commission's portrayal of its position as one of principle
and legal correctness is also questionable. Arguing that
because its forecast estimates that Germany will have a
deficit over 3% in 2004 requires the Commission to use
104(9) because Germany "persists" in failing to adopt
Council recommendations might be tough in front of a judge.

(39) (SBU) The Commission itself chose to exercise the SGP's
flexibility that excessive deficits "should" be corrected in
the year after they are identified by pushing the date out
one more year. In fact, the Treaty, the basis for the Pact,
gives no date certain for the deficits to be corrected.
Both Solbes and Tremonti are correct when saying the
Commission's and Ecofin's positions were, at once,
"political" - both seeking to find a view acceptable to all,
if not a qualified majority of member states, and "law
based" using the SGP rules and Ecofin voting procedures.
The SGP rules provide a framework, not a chemical formula.

(40) (SBU) Existentialist believe that "we are our choices."
Having made their choice, all Ecofin members and the
Commission should come together. Visible, meaningful
results in Germany and France budget programs would be the
most important and necessary step toward this end. Going to
court is a question of finding who has power. Do member
states coordinate fiscal policy or the Commission? That
should be settled in the IGC.

(41) (SBU) Italy's EU presidency has seen two other
decisions in which important interests were overridden by
votes: the Investment Services Directive (UK, Ireland,
Finland, Sweden opposition overridden) and the Takeover
Directive (the Commission's position overridden). As to
whether this is any indication of the current spirit of
cooperation on larger issues, like the ICG, only time will
tell.

(42) (U) This cable coordinated with USEU and Embassies
Berlin, Paris and Rome.

(43) (U) POC: James Wallar, Treasury Representative, e-mail
wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-(69)-
7535-2238

PASI

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