Reports of EMU's still-birth are exaggerated

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The Independent Online
Last week, this column discussed the intensely unpleasant political situation that would be created for the UK if European monetary union went ahead on schedule in 1999, while we opted to remain outside.

Although this would probably be the economically sensible thing to do, at least for a time, it would disenfranchise us on most future policy developments inside the European Union, and carry great political costs. How much better for Whitehall if the impossible dilemma of whether to join should simply disappear - if the whole monetary union project should shrivel up and die.

The British government's desire for this to happen is reaching fever pitch. They know that the present decline in European growth may offer the last and best chance of scuppering the project. So they have decided to rub salt into what is, thus far, not a fatal EMU wound by suggesting that an official postponement will be announced in the next few months. A Machiavellian interpretation, doubtless far too uncharitable, would be that the UK is trying to stir up trouble in the financial markets in the hope that this will force the French to abandon the 1999 start date.

So far, there is no indication from either the French or German governments (which are the only ones that matter) that any change in the Maastricht timetable is imminent. But there are at least three possible ways in which this could conceivably happen this year. The first would be a financial crisis, leading to a final abandonment of the franc fort policy in Paris; the second a loss of political will in Germany; and the third an eventual acceptance by all concerned that the Maastricht convergence criteria will not be hit by 1997.

The first of these possibilities - a financial market attack on franc fort - certainly cannot be ruled out. After all, this is what finally blew up the exchange rate mechanism in 1992/93. But the present policy regime is not as vulnerable to speculative attack as was the old ERM. The central banks are not trying to defend a fixed exchange rate in a narrow band, so they can choose to give ground to the speculators for short periods.

In addition, the core problem four years ago was that the Bundesbank wanted to tighten German monetary policy, while everyone else needed to ease policy. That is not the case now - the German economy is at least as weak as the rest of Europe, if not more so, and the Bundesbank is reducing interest rates in an aggressive fashion.

The fact that the Germans see it as being in their own vital interest to protect the franc means that the situation is objectively very different from that in 1992. Of course, the French nerve might still crack - the next few months could be very bleak as unemployment rises again - but this time there is genuine light at the end of the tunnel. The recent drop in interest rates will be having powerful expansionary effects by the end of the year, and the mood could then change quite dramatically.

What about Germany? Any British official who believes that Chancellor Kohl is spontaneously going to ditch the second great objective of his political life - German reunification being the first - is suffering from delusions. As long as he is around, the German commitment to EMU will be too. There is always the possibility that the Free Democrats will leave the governing coalition, or splinter, thus letting in the Social Democrats, but it would be unwise to bet on it.

This leaves the third possibility - that it becomes apparent in the course of this year that either France or Germany will be unable to meet the Maastricht convergence criteria by 1997. A renewed recession in Europe would certainly leave both countries struggling to hit the required budget deficit (3 per cent of GDP) and debt ratio (60 per cent of GDP) next year.

The table shows the latest Goldman Sachs forecasts for the government finances in Germany and France in the next two years. The main forecast is based on GDP growth of around 1.5 per cent in both countries this year, followed by a renewed acceleration to well over 2 per cent in 1997. Even on this assumption, which many would think is too optimistic, there could be some serious problems for the 1999 start date, since both countries would probably miss the 3 per cent deficit target, and Germany would miss the debt target as well.

However, the real problem would come in the more pessimistic case for GDP growth, which shaves 1 per cent off the level of GDP both this year and next. If this occurs, and if no offsetting budgetary measures are taken, the budget deficits in both countries next year would be close to 4 per cent of GDP, which misses the Maastricht limit by a wide margin.

Or does it? The convergence criteria in the Maastricht Treaty are in fact automatically met if the Council of Ministers, voting by a qualified majority, deem that they are met. It is not a matter of examining figures on pieces of paper - it is the Council's vote that matters.

In reaching its decision, the Council must take the advice of both the Commission and the European Monetary Institute, which in turn are expected to consider whether government finances are "sustainable" and whether deficits are "excessive" or subject to "gross errors".

In deciding this, the Commission and the EMI are asked by the treaty, albeit in rather vague language, to look at the 3 per cent and 60 per cent figures discussed above. But even here there are plenty of loopholes. The debt ratio is permitted to exceed 60 per cent "unless that ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace". And the budget deficit can exceed 3 per cent "unless the excess is only exceptional and temporary, and the ratio remains close to the 3 per cent limit".

The point is that all this leaves an awful lot of room for debate, both inside the Commission and EMI, and within the Council itself.

It may even leave enough room for an unholy alliance of the opt-outs and the left-outs to block monetary union by claiming in the Council that France and Germany have not achieved convergence, even if both countries are determined to press ahead.

A key figure in this debate will be Alexandre Lamfalussy, the President of the EMI. He has recently said that the advice of his institution will be based on a "professional, not a political, interpretation" of the treaty. This has been taken to mean that only a small deviation from the 3 per cent budget limit will be permitted, and certainly the Bundesbank President (who sits on the board of the EMI, and will separately publish his own views) would be expected to take this position.

But you never know. We have seen several times lately that economies can turn on a sixpence. If Europe grows rapidly next year, with budget deficits starting to tumble, the 1999 start date could come back on the agenda - or at least the EU could decide to delay by only a year or two, still under the Maastricht framework. Given these genuine uncertainties, it seems unnecessary for France and Germany to take the crucial decisions any time soon.

So, however many fingers are fervently being crossed in Whitehall, this EMU may not yet be a clinically dead duck.