LONDON: It was meant to the cornerstone of the single currency. Instead it is fast becoming a millstone. In the face of global slowdown the eurozone’s stability and growth pact is a misnomer. It is failing to deliver stability and may yet threaten growth.

To the European Central Bank and the European commission this is heresy — a disastrous backsliding from the economic orthodoxy that dominated the designs of the institutional framework of the euro and continues to rule its monetary and fiscal policy making, at least in theory.

In recent weeks politicians and policy-makers have been lining up to defend the stability pact and to stress its importance to the eurozone’s economic framework. Such is the volume and the vehemence it is hard to avoid wondering whether they are protesting too much.

The pact comes in two parts. First, government deficits — crudely, spending minus tax receipts — must not exceed 3 per cent of gross domestic product, which is an old Maastricht rule.

Secondly, governments are meant to work towards balancing their budgets, with 2004 set as a benchmark date. There is an escape clause that says the rules apply in normal economic circumstances but not if Europe suffers a severe recession.

The ECB argues that the pact provides stability for businesses to get on with investing, making profits and creating employment. The problems are not with the pact or with monetary policy — its own particular responsibility — but with structural rigidities in product and labour markets, which it is up to national governments to tackle.

Yet the architects of what critics have always labelled a bankers’ Europe are facing a serious challenge. A couple of years ago economic growth seemed to bring balanced budgets, the holy grail of monetarists, within governments’ grasp. Economic slowdown is likely to keep it out of reach. Falling revenues and higher expenditure have left finance ministries across the 12-nation single currency zone aghast at the holes blown in their budget arithmetic.

Storm clouds began to gather earlier this year. The European commission wanted to give Germany and Portugal yellow cards, warning them that they were in danger of breaking the pact’s rules. Brussels’ initiative was scuppered by a swift closing of ranks among finance ministers reluctant to see the pact’s architect embarrassed — which meant that Portugal had to be let off too.

The issue has not gone away, however. An incoming Portuguese government has had to confess that the budget deficit it inherited was far worse than the outgoing government had let on, and was well above the 3 per cent ceiling imposed by the pact. So Lisbon will be getting a visit from the Brussels bean counters and, if the beans do not add up, that could mean fines.

If Portugal were the only country in trouble with the pact, however, the world might not care too much.

Within the pact’s broad guidelines countries run their own stability programmes, aiming for balanced budgets. France has pledged to get there in 2004, but has recently hedged the forecast by saying it will hit the target only if its economy grows at least 3 per cent a year — not quite the same as “normal economic circumstances”.

This year’s deficit is ballooning compared with last year’s, therefore growth will fall short. There is talk, too, that Italy might be having problems coming up with the right answers on its deficit planning by 2004.

Germany’s budget battle is being fought on two fronts. It, too, undertook to dump the deficit in 2004, a goal that looks increasingly improbable. More alarmingly for pact supporters it could even bust the 3 per cent deficit this year.

Klaus Zimmerman, the head of one of Germany’s economic think tanks, predicted recently that the 3 per cent limit was in danger unless economic growth picked up while the price of eliminating the deficit in 2004 would be too high.

If Germany does slip slightly beyond the 3 per cent budget deficit threshold analysts reckon that a little creative accounting could see Berlin able to blur an overshoot. Anything bigger and even the fiscal equivalent of smoke and mirrors would not suffice to disguise the damage.

The irony is that the pact/economic straitjacket was brought in at German insistence.

Ross Walker, an analyst at RBS Financial Markets, reckons that while the ECB and the EC will not countenance a formal abandonment of the pact in reality it may simply be ignored.

The fate of the stability pact could have a bearing on British policy towards the single currency. British government policy is to run a balanced budget across the economic cycle. Greater eurozone flexibility, which recognizes there are times when economies grow and others when they do not, would make it easier for the UK to slot in.

One problem for budget busters is the likely reaction of the financial markets. Wattret reckons that, so far, the markets have had more to occupy themselves with than either the spirit or the fine print of the pact — falling stock markets and worries about a double dip in the US to name but two.

But in the long run they may not be so blase. If one or more of the eurozone’s big economies does hit the stability pact limits, governments will have to choose between arousing the wrath of Brussels by bending the rules or angering the voters by cutting spending and raising taxes. Bet then, on a fudge — the last thing the financial markets would enjoy.—Dawn/The Guardian News Service.