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### Viewing cable 03FRANKFURT6409, Stability and Growth Pact: Listerine Syndrome;

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
03FRANKFURT6409 | 2003-08-04 13:47 | 2011-08-24 01:00 | UNCLASSIFIED | Consulate Frankfurt

`

    This record is a partial extract of the original cable. The full text of the original cable is not available.

` `

    UNCLAS SECTION 01 OF 08 FRANKFURT 006409

    SIPDIS

    LONDON FOR HADDA
    TREASURY FOR OASIA

    E.O. 12958: N/A
    TAGS: ECON EFIN EUN
    SUBJECT: Stability and Growth Pact: Listerine Syndrome;
    Striving to Do Good, Good Enough? Key Word -
    Flexibility

    T-IA-F-03-0040

      ¶1.   Summary:  "The taste people hate, twice a day."
         Wretchedly-tasking Listerine's old advertising slogan
         is akin to the criticism of the EU Stability and Growth
         Pact (SGP): we don't like these rules, but we need
         rules at least twice a year when budget results are
         issued.  When Europe was growing, budgets were not
         under strain.  The rules were tolerable.  Slow growth
         has changed all that.  Calls for the SGP to be
         suspended or modified, however, are likely to go
         unheeded.  Where does that leave this debate?

      ¶2.   One way to approach the debate would be to
         distinguish between the "letter" of the SGP and its
         "spirit."  The letter of the Pact is popularly
         distilled into one number, the reference value that
         deficits exceeding 3% of GDP are "excessive."  If an
         excessive deficit were not corrected in the year after
         which it was identified, the member state concerned
         could be subject to sanctions.  The spirit of the Pact
         essentially is that governments should work hard to
         avoid any excessive deficit and, once it occurs, work
         hard to get it back under control.  Economies and
         budgets, being less than clock-work like in their
         predictability, often incur surprises or "exceptional"
         or "special circumstances." Bad things happen.

      ¶3.   At this writing, the outlook seems rather clear
         that Portugal, Germany and France will not abide by
         Ecofin's recommendations to bring their budgets under
         3% value (for Germany and France in 2004) or keep them
         there (Portugal in 2003).  Sanctions, however, are not
         automatic.  Instead, a question EU Finance Ministers
         will collectively decide is whether the member state
         concerned is failing to take necessary corrective
         action. This, necessarily, is a political as well as an
         economic question.

      ¶4.   Flexibility is the word of the day in the SGP
         debate.  Flexibility exists in the rules.  Exercising
         this flexibility responsibility will be a challenge for
         the European Commission and Ecofin.  Being flexible by
         ignoring the rules is one thing.  Being flexible by
         taking into account measurable efforts to get the
         structural deficit under control, including through
         structural reforms, would be quite another.  Such
         efforts could mean brighter growth and budget
         performance.  That, after all, is the point of the SGP.
         End Summary

      SGP:  Storm and Drang Amounting to Very Little

      ¶5.   The SGP is getting its share of hits in the press.
         As the euro area slogs through its third year of
         sluggish economic growth, government budget deficits
         are rising.  Goldman Sachs estimates that for the euro
         area these deficits will increase from 2.2% of GDP in
         2002 to 2.7% in 2003.  Portugal, Germany and France
         have been found to have "excessive deficits," well
         above the 3% of GDP reference value of the Treaty.
         Ecofin has issued all three recommendations to reduce
         their deficits below 3% and keep them there.  Pro-
         cyclical budget policy seems counter-intuitive.
         Wouldn't tightening fiscal policy risk slowing an
         already crawling economy?  Calls for suspending the
         SGP, revising it, or abolishing it seem to be a steady
         diet of some financial journalists.  They are likely to
         amount to nothing.

      SGP Rules: The Basics, Revisited

      ¶6.   Many economists of the euro area agree that fiscal
         rules are necessary for the European Monetary Union.
         The basic argument is to contain the "spillover"
         effects from a country with a high deficit and growing
         debt on interest rates and, consequently, on the
         financing costs of other countries in the union.
         Higher interest rates could put pressure on the
         European Central Bank (ECB) to lower rates, potentially
         conflicting with its primary objective of maintaining
         price stability.  A framework of rules to coordinate
         and discipline 12 national fiscal policies with a
         single monetary policy is designed to avoid such
         spillover effects.
      ¶7.   Even Belgian economist Paul De Grauwe, often a
         critic of the EMU, admits that some rules are
         necessary.  Nonetheless, in his "Economics of Monetary
         Union" published in 2000 he criticized the SGP as being
         "unbalanced" imposing strict rules at the expense of
         flexibility.  He points out that during the 1991-93
         recession six EU countries had government deficits of
         over 3% of GDP.  So why impose such a strict rule if it
         is bound to be broken? To do so risks breaking the
         rules and diminishing the value of the pact.
      ¶8.   Such criticism is, at least to date, misplaced.
         This is the first time the excessive deficit procedures
         (EDP) have been invoked.  It is difficult to know
         beforehand how they will be applied, particularly
         during this period of prolonged economic slowdown.
         Commented a senior Finance Ministry official who
         participated in the drafting of the SGP, the authors
         did not foresee such a long period of stagnation.

      Why 3%?

      ¶9.   3% of GDP reference value seems to be a bit of a
         rough rule.  Yet it does have its logic. If trend real
         economic growth were 3% (the high side of the euro
         area's growth potential), inflation were 2% (the
         European Central Bank's definition of price stability)
         this would imply nominal growth trend of 5% per year
         (which was the average nominal growth rate for the Eu-
         15 during 1991-2000).  If the stock of Euro area debt
         were 60% of GDP (which it was for the Euro area 11
         years ago when the basic rules were being written),
         then a 3% of GDP government deficit would imply no
         increase in the debt relative to GDP.  That is, a
         steady state.

      ¶10.  The rough rule is even a bit rougher in reality.
         As of 2002 the Euro 12 have a debt stock of 69% of GDP.
         Nominal growth has been trending below 4%, likely to be
         closer to 3% this year.  The higher debt stock and
         lower growth imply a deficit of around 2.7% to avoid a
         further increase in debt as a share of GDP.  For
         countries with higher than average debt (Italy) and
         average or below average growth (German), surpluses
         would be in order to reach a sustainable level.  Not
         doing so can put pressure on interest rates and strain
         on monetary policy, as noted above.  No wonder small
         countries that have moved close to budget surplus
         during the cyclical upswing are displeased with the
         larger countries that did not (France, Germany) or who
         did not bring down their overall debt levels (Italy).
         France is a special case: debt level around 60% and
         growth rates around average.

      ¶11.  The 3% reference value also is attractive because
         it is relatively easy to explain and as transparent as
         Eurostat can make it.  More sophisticated measurements
         of cyclically adjusted numbers are used by the
         Commission to monitor trends.  These lack clarity
         (assumptions could vary) and simplicity.

      ¶12.  The rules are unlikely to change.  The recent
         draft Treaty establishing a Constitution for Europe
         incorporated the SGP rules, without substantive change.
         Similarly, in its May 2003 Concluding Statement of its
         Article IV consultations on the Euro Area Policies, the
         IMF mission stated that the 3% limit "is and must
         remain one of the key references values of the monetary
         union."  "An Agenda for a Growing Europe" issued by an
         Independent High-Level Study Group chaired by Belgian
         economist Andre Sapir in July 2003, argued that the 3%
         of GDP upper limit should be kept to "steer fiscal
         discipline." Nonetheless, there is another way to
         approach the issue, namely, flexibly.

      Need for Flexibility

      ¶13.  De Grauwe's view on flexibility has become the
         keyword of the day.  Sapir's High Level Study Group
         pleas for more differentiation in applying the SGP,
         taking into account a country's debt level, and for
         more flexibility in the case of severe cyclical
         downturns.  For the latter, the High Level Study Group
         recommended changing the definition of the term
         "exceptional circumstances" to be defined as simply a
         negative annual growth rate rather than a 2 percent
         decline.  This would require a change in the Treaty.
         Others, such as the ECB, argue that the SGP already has
         sufficient flexibility.  Which is correct?

      Rules of the Game:  Economists As Wanna-be Lawyers

      ¶14.  To understand the debate, familiarity with the
         rules of the game is helpful.  This can be a chore.
         The SGP is not one tidy document, but is composed of
         Treaty Articles and Protocols and Council Regulations
         and Resolutions.  Article 104(2) of the Treaty states
         that the Commission is to monitor member states'
         budgetary situation and whether they comply with the 3%
         reference value unless the excess over 3% is declining
         close toward 3% or is "only exceptional and temporary."
         Article 2(1) of Council Regulation (EC) No 1467/97
         ("the Council Regulation") defines "exceptional and
         temporary" as resulting from an unusual event outside
         the control of the member state concerned and which has
         a major impact on the financial position of the general
         government or when resulting from a severe economic
         downturn.  A severe economic downturn is exceptional
         only if there is an annual fall of real GDP of at least
         2%, according to Article 2(2).

      ¶15.  Article 2(3) refines the point by allowing the
         Commission to examine "other supporting evidence" that
         would suggest an exceptional circumstance, even if the
         decline is less than 2%.  Such evidence includes the
         abruptness of the downturn or the accumulated loss of
         output relative to past trends.  The Resolution of the
         European Council on the SGP ("the Council Resolution")
         further commits member states not to invoke the
         benefits of Article 2(3) unless they are in a "severe
         recession," further defined as an annual fall in real
         GDP of at least 0.75%.

      ¶16.  For Portugal, Germany and France, the Commission
         considered whether exceptional circumstances were at
         play and, at the time it was preparing its report,
         decided in the negative.  Thus, it issued a report that
         these countries' deficits were excessive.  Ecofin
         agreed and issued recommendations to each of these
         countries to "bring the situation to an end."  As
         provided for under the Council Regulation, Ecofin gave
         the Member country concerned four months to take
         effective action.  Article 3(4) of the Council
         Regulation states that the deadline for the correction
         of the excessive deficit "should be completed in the
         year following its identification unless there are
         special circumstances."  Under the Council Resolution,
         member states have committed themselves to this action.
         The phrase "special circumstances" is not defined
         either in the Council Regulation or Council Resolution.

      ¶17.  What happens if the deficit is not corrected?
         Article 104(9) of the Treaty states that: "If a Member
         State persists in failing to put into practice the
         recommendations of the Council, the Council may decide
         to give notice to the Member State to take, within a
         specified time-limit, measures for the deficit
         reduction which is judged necessary by the Council in
         order to remedy the situation."  If the Member State is
         not implementing the recommendations or the measures
         are inadequate, Ecofin is to take action, on the basis
         of a recommendation from the Commission, either under
         Article 104(9), that is give a (or another) notice or
         under Article 104(11), resort to sanctions.  Or if the
         excessive deficit has not been corrected within the
         time limits specified either in the initial EDP or a
         notice issued under 104(9), Ecofin can again issue
         another notice under 104(9) or move to sanctions.

      ¶18.  Sanctions can be invoked "as long as a Member
         State fails to comply with a decision taken in
         accordance with" 104(9).  Thus, a Member State would
         have to "fail to put into practice the recommendations"
         of Ecofin and would have to fail to comply with
         recommendations in any follow-up notice.  In short, be
         incorrigible.
      Sanctions:  Deterrent or Admission of Failure?

      ¶19.  For the record, sanctions themselves are also a
         drawn out affair.  When Ecofin takes a decision under
         104(11) a non-interest-bearing deposit is to be
         required.  This would consist of a 0.2% of GDP fixed
         component and a variable component of one-tenth of the
         difference between the deficit as a percentage of GDP
         and the 3% reference value.  The total deposit cannot
         exceed 0.5% of GDP.

      ¶20.  The deposit is converted into a fine if two years
         after the deposit was required the excessive deficit
         had not been corrected. A German Finance Ministry
         official admitted that just how the fine would be
         imposed has not been thought through.  "You see, when
         we drafted these provisions, they were not meant to be
         used, but to serve as a deterrent. "

      ¶21.  Article 104(11) includes other possible measures:
         require the member state concerned to publish
         additional information before issuing bonds and
         securities or invite the European Investment Bank to
         reconsider its lending policy to the Member State
         concerned.

      Now we turn to the application of the rules to the
      "live cases" of Portugal, Germany and France.

      Portugal: Brightness Before the Burn Out?

      ¶22.  In November 2002, Ecofin decided that Portugal's
         2001 deficit of 4.1% was excessive.  The Council's
         recommendation called for (a) putting an end to the
         excessive deficit as rapidly as possible (i.e. the year
         following its identification, 2002); (b) implementing
         budget plans for 2002 that would bring the deficit down
         to 2.8%; and (c) implementing necessary measures to
         ensure the 2003 budget is below 3%.

      ¶23.  The GOP went through hell and high water to meet
         (a) and (b).  In the event, the deficit came in at
         2.8%.  In March 2003, however, the Council did not
         "abrogate" their excessive deficit decision.  Rather,
         they wanted to assess the sustainability of the deficit
         remaining below 3%.  According to Commission officials,
         prospects are not good.

      ¶24.  Portugal's economy is contracting and the deficit
         may well shoot up to 5% of GDP, according to Commission
         experts. UBS Warburg suggests part of the contraction
         was due to budget consolidation, between 0.7% to 1.3%.
         In September Eurostat will give its assessment of the
         budget outlook for 2003.  The Commission is likely to
         make an assessment either in September or shortly after
         the final 2003 budget numbers are published in March
         ¶2004.  The Commission is likely to make a report with
         recommendations to Ecofin.

      ¶25.  How might this case be handled by the Commission
         and Ecofin?  Under the "letter" of the rules, the
         Commission is considering whether, in fact, there are
         "special circumstances" given the decline in GDP.  As
         noted above, the phrase "special circumstances" under
         the Council Regulation regarding the correction of the
         deficit (Article 3(4)) is not defined. This contrasts
         with the phrase "exceptional" under Article 2(3) of the
         Council Regulation when the Commission makes its
         initial assessment of whether a deficit is excessive.

      ¶26.  With regard to the "spirit" of the rules, the GOP
         probably can make a good case that they have complied
         as much as possible with the Ecofin recommendations.
         They pushed the deficit below 3% in 2002, as
         recommended, and are committed to achieve a sustainable
         deficit under the 3% reference value.  Ecofin noted
         that the GOP is moving to improve the collection and
         processing of government data, reinforce mechanisms to
         coordinate budgetary policy, and implement policies to
         foster growth, employment and competitiveness.
         Whatever the Commission and Ecofin do on Portugal will
         set a precedent for the German and French cases to
         follow.
      Germany:  Miss America on Your Arm or Egg in Your
      Face

      ¶27.  In January 2003 Ecofin determined that Germany had
         an excessive deficit.  They recommended that the German
         government (a) put an end to the excessive deficit as
         rapidly as possible in accordance with Council
         Regulation Article 3(4) (i.e. the year after the
         deficit was identified, 2004); and (b) implement their
         budget plans for 2003 which, on the basis of German GDP
         growth projections of 1.5% in 2003, aim at reducing the
         deficit in 2003 to 2.75% of GDP by adopting budgetary
         measures of 1% of GDP.   Ecofin "noted" the commitment
         of German authorities to implement structural reforms
         and to reduce the underlying budgetary deficit by more
         that 0.5% of GDP per year, with the exception of 2005
         due to the introduction of income tax reforms.

      ¶28.  The German government's budget plan for 2003
         achieves a budget deficit reduction of almost 1%, in
         structural terms, at least on paper.  This plan passed
         muster in the four month review of German budget
         performance in May.  However, the decline in growth,
         probably close to zero this year, will help push the
         deficit close to 4% in 2003.  Under the "letter" of the
         rules, the deficit need not be corrected until 2004.

      ¶29.  Unfortunately, 2004 doesn't look much better.
         Germany has announced that it will bring forward the
         income tax cut scheduled for 2005 to January 2004, and
         implement income tax cuts that had been postponed from
         January 2003.  Combined this would amount to a revenue
         loss of around 1.3% of GDP,  only part of which would
         be financed through reduced expenditures.  Goldman
         Sachs estimates that the deficit will linger around 4%.

      ¶30.  The German Finance Ministry differs.  It hopes
         that income tax cuts combined with structural reforms
         and structural budget consolidation through subsidy
         reductions will give a boost to economic growth to
         around the Finance Ministry's assumption of 2%.  This
         should help push the deficit toward the 3% level.

      ¶31.  This strategy is risky, in the view of a senior
         ECB official.  The income tax cuts may be pocketed by
         politicians without making the important structural
         reforms and subsidy cuts.  Finance Ministry officials
         admit that there are risks.  It is a package deal - no
         structural reforms or subsidy cuts - then no income tax
         cuts in 2004.  Success would be a "great step forward."
         Failure would be "catastrophic," in the words of a
         senior Finance Ministry official.  Miss America on your
         arm or egg on your face.

      ¶32.  Under the SGP rules, German Finance Ministry
         officials say they will argue "letter" and "spirit."
         Like the case of the Portuguese, they will argue that
         not realizing their assumed growth projections and the
         prolonged economic stagnation are  "special
         circumstances" that have prevented correction of the
         deficit by 2004.  As noted above, this phrase is
         undefined.  German Finance Ministry officials hope the
         Commission will exercise some discretion.  German
         Finance Ministry officials explain that they will keep
         to the commitment of an average annual reduction of its
         structural deficit of 0.5%, with a pause in 2004, due
         to the income tax cuts, rather than in 2005 when these
         cuts were originally scheduled to be implemented.

      ¶33.  With respect to "spirit," Ministry officials say
         they will point out that the government followed
         Ecofin's recommendation to stick to their 2003
         reduction plan, e.g. reduction of the structural
         deficit by nearly 1%.  Rather than boosting confidence,
         as the Commission and ECB had suggested it might,
         confidence languished.  The announced program of
         structural reforms and bringing forward the tax cuts
         has provided the sweetener to push through subsidy cuts
         envisaged in the budget consolidation program.  The
         idea of advancing the income tax cuts, they will argue,
         is to bolster confidence while keeping their
         commitments to Ecofin to cut the deficit over time and
         undertake structural reforms.  After all, getting below
         the 3% reference value depends as much on the
         denominator as the numerator, that is, on growth as
         much as the absolute size of the deficit.

      ¶34.  Commission officials privately are not convinced
         by the "special circumstances" arguments.  In a speech
         in Berlin on July 1 European Commissioner Solbes was
         "quite clear": "the Commission expects that Germany
         will respect the EMU policy framework.  A general
         government deficit above 3% of GDP in 2004, for the
         third year in a row, would be incompatible with our
         common budgetary rules."
      ¶35.  At the conclusion of the Fund's Article IV
         Consultation with German authorities, the Fund mission
         expressed support for the strategy of packaging
         structural reforms, budget consolidation through
         reduced expenditures, and advancing income tax cuts.
         The mission conceded, however, that advancing the
         income tax cuts "will make the fiscal arithmetic for
         2004 difficult," and that getting below the 3%
         reference value will "be a challenge" in 2004.  But
         overall, the mission sensed that "the prospect for
         meaningful structural change is finally in the air. If
         proposed reforms are implemented and fiscal
         consolidation put on firmer ground, we are optimistic
         that Germany's economy can put a long period of weak
         performance behind it."  Testimony on behalf of
         Germany.

      ¶36.  The first indications of the budget for 2004 will
         be in the budget plan to be agreed by the end of this
         year in Germany.  If the budget plan has a deficit of
         3% for 2004, perhaps with the help of "aggressive
         assumptions" on growth and revenues, the first real
         evidence of actual results will appear only in
         September 2004 when Eurostat publishes its preliminary
         estimates.  Final figures for 2004 will be available
         only in March 2005.  On each of these dates, the
         Commission could launch a report with recommendations
         to Ecofin.

      France:  Unique, naturalement

      ¶37.  In June Ecofin determined that France had an
         excessive deficit.  They recommended that the French
         authorities (a) put an end to the excessive deficit as
         rapidly as possible and by "2004 at the latest;" (b)
         achieve a "significantly larger improvement in the
         cyclically adjusted deficit in 2003 than currently
         planned," and (c) implement measures to ensure that the
         cumulative improvement in 2003-2004 is enough to bring
         the nominal deficit "below 3% in 2004 at the latest."
         Ecofin noted the commitment of French authorities to
         ensure tighter control of expenditures and to achieve
         pension reform.

      ¶38.  As reported septel, this decision was not
         supported unanimously, the Dutch and the Danes
         dissenting.  Ecofin had issued an "early warning" to
         the French in January calling for "at least 0.5
         percentage point of GDP" improvement in its cyclically-
         adjusted budgetary position.  In March the French
         government's official forecast showed only a 0.1
         percentage point improvement.  It seemed that the
         French had not taken to heart Ecofin's earlier
         recommendation.

      ¶39.  Reiterating the call for a 0.5 percentage point
         cut in June when half the budget year was over seemed
         unrealistic, according to Commission experts.  Thus,
         the formula was agreed that there should be an average
         reduction of 0.5 percentage points annually over the
         two years, 2003-2004.  This suggests a one percentage
         point cut in 2004. Moreover, Commission experts expect
         the French deficit to be close to 4% of GDP in 2003.
         Thus, a percentage point reduction in the deficit would
         be necessary in 2004 in any case.  Commission staff
         consider such a deep cut problematic.  German Finance
         officials consider it the maximum possible.

      ¶40.  The next step for France will come on October 3.
         Under the SGP rules, this will be the four month
         deadline by which time French authorities must explain
         the measures they will take to comply with Ecofin's
         recommendations.  This will be a time of testing of
         whether France is serious about respecting the SGP, at
         least on paper.

      ¶41.  German Finance Ministry officials, while quick to
         emphasize their wonderful working relationship with
         France, just as quickly distinguish their position on
         the SGP from France's.  They assert that they are
         sticking by the rules, if not the letter at least the
         spirit.  In their view, France is doing neither.

      ¶42.  The IMF also has supported the French Government's
         basic economic strategy, in particular "the structural
         orientation of policies and the intention to resume
         fiscal adjustment." In its Article IV Consultation
         Concluding Statement issued in June, the IMF mission
         praised the legislation of the "key and difficult
         milestone" of pension reform.  The Fund notes that the
         2003 deficit will be more than one percentage point
         higher than planned and supports the objective of
         reducing the underlying general government budget
         deficit by 0.5 percentage points in 2004.  Such a
         modest reduction would not be in line with Ecofin's
         recommendation.

      ¶43.  The Fund mission goes on to point out that the
         "credibility of the government's fiscal and economic
         policy strategy hinges crucially on its ability to
         reduce the share of public spending in GDP."  Notably,
         it points out that priority structural areas identified
         by the government for reform (pension, health care,
         reform of the state, and decentralization) will help
         reduce expenditures as a share of GDP and "illustrate
         the synergies between budgetary reform and possible
         increases in potential growth."  Here, as in the case
         of Germany and Portugal, is the connection between
         fiscal discipline, structural reforms and growth.  An
         argument that France is operating within the "spirit"
         of the SGP.  Moreover, France could argue that its past
         growth rates and debt position suggest that its deficit
         is sustainable - at least for a while - and not putting
         pressure on the euro system.

      Growth and the SGP

      ¶44.  The stated objective of the SGP is "sound
         government finances as a means of strengthening the
         conditions for price stability and for strong
         sustainable growth conducive to employment creation."
         This suggests that discretionary fiscal policies should
         be avoided so as not to burden monetary policy, and
         foster low interest rates that are conducive to long-
         term planning and investment.  For most EU countries
         this means cutting expenditures to achieve a more
         sustainable level of debt or to avoid increased in debt
         in order to ensure its sustainability when increased
         expenditures become unavoidable due to aging
         populations.

      ¶45.  In its June 2003 report on "Public Finances in the
         EMU," the Commission notes that budgetary consolidation
         "often acts as a catalyst for structural reforms."
         Structural reforms can boost growth and growth
         potential.  As the Commission notes in that report,
         "the effect of budgetary consolidation on output could
         be reinforced, and even positive, in the short-run if
         fiscal consolidation is combined with structural reform
         of factor and product markets and accompanied with an
         accommodating monetary stance."

      ¶46.  So that's the deal for growth: budget
         consolidation, structural reform, accommodative
         monetary policy.  Interest rates are at record lows.
         Pressure has grown for structural reforms due to budget
         pressures.  It would be more than a pity to relieve
         that pressure now.   No wonder Dutch Finance Minister
         Zalm, noted for his tough stance on deficits, has
         called for fines for France and Germany if they fail to
         get their finances in order next year.

      ¶47.  How could flexibility be applied without
         sacrificing the rules? One point is that when Ecofin
         made its recommendations for all three countries, the
         Commission's and ECB's forecast was for much more
         robust growth than has occurred.  Thus, the rising
         deficits could be due, in part, to cyclical factors.
         In November 2002 the European Commission agreed to give
         importance to cyclically adjusted budget balances in
         its surveillance and ensure a cyclically-adjusted
         budget position of at least 0.5% of GDP and more
         emphasis on the quality of public expenditures that are
         conducive to growth and employment.

      ¶48.  The IMF Mission on Euro Area policies has praised
         these measures.  Specifically the Fund staff liked the
         notion that countries with excessive deficits make
         adjustments of at least 0.5% of GDP per year in
         cyclically adjusted terms and that multi-year
         consolidation plans should aim at curbing expenditures.
         The Fund staff admits, however, that these steps will
         not ensure deficits drop immediately below 3%.
         Nonetheless, they argue that those countries that
         follow these guidelines of "0.5 percent high quality
         multi-year adjustment" should be "considered on a
         sustainable path toward compliance with the Pact."
         Striving to do good should be good enough.

      ¶49.  Maintaining a judicious balance between enforcing
         the letter of the SGP while safeguarding the spirit
         will be the next challenge for the Commission and
         Ecofin.  No one said that coordinating 12 national
         budgets during a prolonged economic downturn would be
         easy.

      ¶50.  This cable coordinated with Embassies Berlin,
         Lisbon, Paris, Rome, the Hague and USEU Brussels.

    (U) POC: James Wallar, Treasury Representative, e-mail
    wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-
    (69)-7535-2238.

      Herrman

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