The European Commission warned the German and Portuguese governments to cut their budget deficits this year, when both face elections, saying growing deficits risk damaging the credibility of the euro.
The first formal warning since the euro's introduction is a blow to German Chancellor Gerhard Schroeder, who has made deficit reduction a priority. It also highlights Germany's economic plight, when Schroeder is counting on a recovery to create jobs and boost his chances of reelection in September.
Germany is heading for a deficit of 2.7 percent of gross domestic product this year, the commission forecast. That's close to the 3 percent limit set by rules that Germany itself devised for the dozen nations using the euro. Countries that breach the 3 percent limit can be fined.
"The credibility of the pact is at stake," Monetary Affairs Commissioner Pedro Solbes said. Germany and Portugal will find it "difficult to achieve the balanced budgets they are aiming for in the medium term unless they pursue additional adjustment efforts."
The move puts the commission at odds with German Finance Minister Hans Eichel, who said last week a reprimand wouldn't change his budget policy. He may succeed in annulling the commission's verdict by lobbying other finance ministers to vote against it at a meeting on Feb 12.
The rebuke "is just like being spanked by the European Commission," said Otmar Lang, an economist at Deutsche Bank AG in Frankfurt. "If you get spanked, you don't do it again."
Germany sank into recession in the second half of last year as companies like Siemens AG said they would cut 130,000 jobs.
Lengthening unemployment lines have damaged Schroeder, who was forced in November to take back his pledge to bring the jobless rate below 3.5 million before the end of this year.
Germany can probably count on the support of Portugal, which the commission said is also in danger of breaching its deficit limit. Portugal was criticized for spending more than it aimed to last year, leaving it little slack in its budget to respond to the economic slowdown. The commission said its earlier deficit forecast of 1.6 percent for this year "is no longer valid." Under EU voting rules, Germany and Portugal could block the move with the support of France and one other country.
The euro area's second and third largest economies escaped without a formal warning, because they're not in immediate danger of breaching the 3 percent limit. "France and Italy are not exactly improving their budget situation, but at least they are not going in the wrong direction like Germany and Portugal," said Paul Mortimer-Lee, chief economist at BNP Paribas Capital Markets.
Plans by France, set for a 2 percent deficit in 2002, "are not all that ambitious," Solbes said. Italy, heading for a 1.2 percent deficit, "has a high debt ratio and the quality of some of the measures to achieve the targeted deficit reduction is questionable."
Progress in Spain, where the commission forecasts a 0.2 percent deficit, is "broadly satisfactory," while Greece needs to keep reducing its debt, he said.
Ireland, the bloc's second-smallest economy, got the EU's only previous economic-policy reprimand, although that was under a different set of rules that do not lead to fines. Ireland was criticized last year for using tax cuts to stoke an already booming economy. The remarks were later withdrawn when Irish inflation abated.
In Germany, slowing economic growth caused welfare benefits to rise and tax revenue to fall, widening the government's deficit. Little relief is in sight: Eichel on Wednesday cut his forecast for Germany's economic growth this year to about 0.75 percent.
The political blame game has begun. "If the previous government had started a policy of fiscal consolidation four years ago, we'd have a balanced budget now," Eichel said after the government released its annual economic report.
Germany depends more on trade with the US than other European countries, so it should have reduced its deficit last year to build up a war chest for use when the economy slowed, said BNP Paribas' Mortimer-Lee.
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