Too soon to forecast Emu's extinction

Ministers are hostile, bankers baffled, but monetary union is still on the cards
Malcolm Rifkind is downright hostile. Kenneth Clarke hopes it will be delayed. British businessmen and bankers gathering for a seminar this week were baffled that Europe had ever got this far down the single-currency road. Across the country, the British cannot quite believe Emu is really going to happen.

But extricating ourselves for a moment from the Anglocentric perspective, the picture looks rather different. Admittedly, Germany is now in a much worse position than expected and many problems remain to be ironed out. Nevertheless, it is far too soon to write Emu off. Critical to the project is Germany. As Bruce Kasman of JP Morgan explains: "If Germany does badly this year, the whole process is at risk."

The Maastricht treaty says members joining monetary union have to fulfil certain criteria, the aim being to ensure different economies are close enough together to cope with a common currency and common interest rates.

The trouble is that Germany's ability to meet the debt and deficit criteria in 1997 is in serious doubt. Julian Jessop of Nikko Europe believes "it is next to impossible for Germany to meet a strict interpretation of the Maastricht criteria."

Unemployment last month was higher than anyone expected, pushing up spending on benefits and squeezing taxation revenue. The government currently forecasts borrowing in 1997 of 2.9 per cent of GDP. However, many City analysts reckon the figures will be considerably higher. Robert Prior of James Capel says: "Germany is looking very vulnerable. Our central view is that Emu will be delayed."

But it is too soon to write Germany off. Costs of reunification and the timing of corporate restructuring have hit it hard. But Mr Kasman predicts growth could start picking up this year."Growth is the make or break issue for EMU. If we get growth in 1997 then EMU will go ahead. We are still optimistic that EMU will go ahead on time," he said. And even if growth and unemployment remain sluggish, the political will in Germany is such that more spending cuts could still materialise.

Even if Germany does not meet the Maastricht criteria, the game is not over. As Philip Chitty of ABN Amro points out "the [European] Commission is about deals and compromises." Monetary union between countries with deficits roughly 3 per cent (give or take 0.2 per cent here and there) could yet be "fudged" together. On current forecasts that probably means Germany, France, the Benelux countries, Austria, and, more surprisingly, Finland and Ireland. Even Portugal could squeeze itself in.

But what about Italy and Spain? On this the entire project could turn. Italy is desperate to get into a single currency as fast as possible. Yesterday the Prime Minister, Romano Prodi, promised another mini-budget to squeeze Italian finances into shape.

Bizarrely, if Italy is successful, that could jeopardise EMU.

The German public are particularly hostile to monetary union which includes the Italians, fearing the impact of the Italian history of financial and political instability on the strength of the new currency.

A plausible first wave for monetary union in 1999 depends on the Commission being able to draw a credible line between the ins (including Germany) and the "pre-ins" (including Italy), while keeping Italy happy with a deal on joining the Emu club in the years to come. Should Spain fail to meet the Maastricht criteria too, Italy will lose less face and political compromise might be easier.

In the long term, sustainability of the single currency will depend on member-states' ability to cope with common interest rates, in particular on governments' ability to use tax and spending to cope with local economic problems once devaluation is no longer an option.

But these kinds of policy questions will hardly get a look-in in the battle to decide who gets in, and whether Emu goes ahead at all. Instead, it will be the performance of the German and Italian economies, and the determination of European politicians that matter most.

The Maastricht criteria

Government debt should not be more than 60 per cent of GDP. The government deficit should not be more than 3 per cent of GDP. Inflation should not overshoot the performance of the three lowest inflation countries by more than 1.5 percentage points. (In 1996 that meant consumer price increases of less than 2.5 per cent). Long-term interest rates should not be more than 2 percentage points higher than in the three lowest inflation countries. (In 1996 that meant not higher than 9 per cent). The currency should operate within the ERM margins for two years without devaluing.

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