German threat to scupper currency pact

A growing power battle between Germany and other Europeancountries over who lays down the law for the single currency could prevent agreement in December on a crucial system of budget rules and sanctions.

It had been expected that a long-awaited "stability pact", containing rules for governing the use of the euro, would be signed at the Dublin summit in December.

However, European finance ministers, meeting in Brussels yesterday, failed to decide what those laws should be. The ministers were also far from deciding what European body should enforce the laws. Jean Arthuis, the French finance minister, has proposed radical plans, supported by Germany, for a new informal "economic government" to be called a "stability council".

The council would operate as a "G7-style club", modelled on the Group of Seven industrial countries, and consisting of only states inside the single currency.

Creation of such an exclusive new political club would have serious implications for Britain, which would be excluded if it "opts out". Yesterday Kenneth Clarke, the Chancellor, said he was "very sceptical" about the idea of such a "discreet club" which could create new division between those inside economic and monetary union (EMU) and those outside.

The creation of a stability pact and stability council are the single most important building blocks for EMU, and a delay will raise questions about the determination of member states to proceed.

Germany, which first proposed a "stability pact" a year ago, wants the rules for budgetary discipline to be as strict as possible in order to ensure that the euro is as strong as the mark. Without firm evidence that its partners will keep their spending under control, Helmut Kohl, the German Chancellor, fears he may be unable to sell the single currency to his own public. A senior German official said: "It is vital that our government achieves the results it wants. Without an effective stability pact the German public will not be convinced."

German frustration with the laxity of rules currently being proposed has pushed Bonn to threaten to opt out of the current negotiations altogether, by seeking tougher deals with only those countries who qualify to join at a later date. Such deals would be done outside the terms of the Maastricht treaty. Germany has underpinned its threat by saying it has legal advice that it has the power to go it alone, should other member states not toe its line.

However, most other EU member states, including Britain, hope that Bonn's hard line is a bargaining threat. Germany's stance would place them in an unacceptable economic straitjacket, they say.

Under the complex system of rules for the stability pact now on the table, each country inside EMU must accept a sliding scale of fines if it allows its budget deficit to rise above 3 per cent of gross domestic product. Exemptions can be made for countries in "exceptional circumstances" - for example, if they have suffered a natural disaster. Exemptions can also be made in cases of a severe economic downturn. Germany's prime demand is that the "severe economic downturn" be defined far more tightly than the Commission or its partners can accept. Germany is also demanding stricter rules for enforcement of fines against countries which let their budget deficits slip out of line.

As other member states focused on German demands yesterday, Mr Clarke, found himself obliged to justify to Euro-sceptics back home his repeated support for a stability pact. Critics say the pact would force Britain, should it sign up, to an unprecedented transfer of sovereign powers. Public spending and tax would in future be scrutinised by Brussels and the Government would be fined if it stepped out of line.

However, Mr Clarke yesterday countered that the stability pact can only be good for Britain as it aims to ensure sound economic management, which is already part of government policy.

The pact would help keep European interest rates down, and this could only be good for Britain whether it is "in" or "out" of the single currency, said the Chancellor.