The move follows growing anxiety in Whitehall that the Gibraltar government has been dragging its feet over the implementation of a series of EU directives which are, among other things, intended to curb money-laundering and other deviations from normal banking practice.
Spanish government allegations that Gibraltar has become a haven for money-laundering and drug-smuggling underlie a renewed border dispute between Madrid and the Rock, which has seriously upset British-Spanish relations in recent weeks.
The seriousness with which the British Government is taking the issue is underlined by the fact that a high-powered ministerial committee is monitoring the ultimatum.
This was presented to Gibraltar's Prime Minister, Joe Bossano, in a letter from the Foreign Secretary, Douglas Hurd. Mr Bossano was summoned to London in September to receive the letter personally. "We have given them a list of 51 things to do,'' said one source.
Whitehall sources acknowledge that the ultimate threat is direct rule though unspecified "intermediate steps" could be used to "turn up the heat" first.
However, while limited progress has been made in setting in motion the "good government package'' it is nowhere near enough to satisfy Whitehall, which has set a four-month deadline which expires in late January.
One Westminster source said last night that direct rule creating a "mini-Stormont'' should not be ruled out.
According to senior British Government sources, the detailed letter handed over by the Foreign Secretary does not explicitly threaten direct rule. But in the words of one source, the threat was "left hanging" as the ultimate sanction that could be imposed.
Britain has the right to disband Gibraltar's elected assembly and impose direct rule under the terms of the 1969 constitution. The Government has reserved the right to amend or revoke Gibraltar's constitution unilaterally and to pass laws "for the peace,order and good government of Gibraltar".
Mr Bossano's chef de cabinet, Ernest Montado, reacted angrily yesterday when pressed about the British ultimatum. "Our eyes have always been fully open to that possibility. But if the British Government were to even dream of doing that, they would be in for a very tough time in Gibraltar," he told the Independent.
"The reaction would be, well, there would be total chaos. For the British Government to remove the democratic power of the Gibraltar government would be completely unacceptable. There would be civil unrest. I'm not saying there would be violence, but th e y [the British Government] would be in serious difficulty."
In September Britain gave Gibraltar a long shopping list of demands and offered to help draft legislation to ensure that it was consistent with EU directives on such issues as money laundering, open tendering for public contracts and offshore banking. Other directives cover less contentious issues.
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