Euro faces fresh test as France challenges stability pact

The credibility of the euro faces a crucial test today, when France leads objections to a package of economic guidelines designed to curb borrowing and underpin Europe's single currency.

At a meeting of EU finance ministers in Madrid, Britain will also try to water down a document that specifies detailed economic targets for all EU countries.

But while British officials argue that their objections can be overcome, France and Germany are locked in an increasingly fierce struggle – with much higher stakes – over economic policy within the 12-nation eurozone.

The euro, despite its recovery on the international money markets, has been dogged by a dispute over how strictly to interpret rules designed to control public finances of member states. The election campaign that returned Jacques Chirac as French President and brought about a centre-right government in Paris, promised increased spending on public services and a substantial package of tax cuts, costing an extra €2.7bn (£1.8bn) this year.

Concern that France may renege on a pledge by all EU member states to get public finances in surplus or close to balance by 2004 was heightened when Mr Chirac suggested pushing the date back to 2007.

Although Germany narrowly avoided an official warning earlier this year over its levels of borrowing, the government in Berlin has taken a hard line with France. Earlier this week, German officials briefed journalists that France was heading for a budget deficit of about 2.6 per cent this year, only slightly below the 3 per cent maximum allowed under rules known as the Stability and Growth Pact for countries in the eurozone. The tough line from Berlin may be connected with keeping up political appearances before Germany's elections in September.

The document due to be finalised tonight, known as the Broad Economic Policy Guidelines, is designed to reinforce the Stability Pact.

Earlier this week Jean-Claude Juncker, the Prime Minister and Finance Minister of Luxembourg, floated a possible escape clause for France, by linking its commitments on public finances to economic growth performing as predicted.

The Spanish presidency of the EU is expected to suggest that the 2004 target for reaching equilibrium is retained in the final text, but with the additional phrase "in so far as the forecast growth scenario is confirmed". France agreed to the 2004 target on the assumption of 3 per cent annual growth, which is at the high end of economists' forecasts.

Yesterday one Commission source described such a compromise as a matter of "presentation" because flexibility is already written into the guidelines in the event of growth being lower than expected.

Gerhard Schröder, the German Chancellor, kept up the pressure on France, arguing: "We are fulfilling the Stability and Growth Pact and will behave economically responsibly."

Britain argues that its commitment to be close to balance or in surplus by 2003-04 should be interpreted flexibly, taking into account other factors such as its low levels of debt, the point in the economic cycle and the need to borrow to invest in infrastructure.

Although British officials believe that the text of the document can be amended to reflect this, they believe it points to a continuing argument over the way the pact operates.

"Clearly there are concerns about the way the Stability and Growth Pact is being implemented," said one British source. "We think we can find a way around the short-term issue but that does not resolve the underlying problem."

In addition to France and Britain, Portugal, Belgium and Germany have problems with some part of the text to be discussed tonight.

Chris Huhne, economic policy spokesman for the Liberal group in the European Parliament, said: "It is pretty crucial that we come to a much better and clearer understanding of how the Stability and Growth Pact is going to operate."