The Three Per Cent Ceiling

The West German finance minister, Theo Waigel, must be regreting his statement: "Three per cent is three per cent." It reflected the German governmenet's then attitude to a strict adherence to the Maastricht criteria for economic and monetary union (EMU), which stipulates union (EMU), which stipulates three per cent of GDP as the ceiling on the 1997 fiscal deficit for a member country participating in the single European currency. In the last few weeks, Waigel has started backing down. Three per cent, it seems, is no longer three per cent.

To be sure, the Maastricht treaty itself provides flexibility on the budget deficit provided "either the ratio has declined substantially and continuously and reached a level that comes close to three per cent or alternatively the excess over the reference value is only exceptional." It seems that if EMU is to go ahead as per the present schedule, Waigel and the German government will have to take recourse to the proviso quoted above. Thus, three per cent could become 3.1 per cent or 3.2 per cent. And the same flexibility will have to be allowed to other participants.

This issue, and indeed the whole future of the single European currency, the euro, has come under a cloud in the last few weeks, primarily because of the new government in France, and Waigel's botched plan to revalue gold. Both developments were unanticipated.

President Chirac called for a premature parliamentary election in the hope that his ruling coalition would be re-elected and wlould have a mandate to take the measures necessary to meet the Maastricht criteria. The volters, tired of growing unemployment and resenting the fiscal deflation imposed by the government, however, had other ideas.

They voted the opposition socialists into power. Prime minister Jospin and his cabinet, which includes the communists (who are, in any case, opposed to the introduction of a single currency), are perhaps less committed to EMU. They are more worried about the implications of the tight fiscal policies to growth and employment mandated by Maastricht, and prefer the looser interpretation. The French also want a broad EMU including Portugal, Spain and in particular, Italy, despite the traditional fiscal profigacy of the Italians. The preference for a broad EMU arises from French worries that outside EMU, and with a weaker currency, Italian industry would pose a major threat to French exports and jobs.

The new French government three another spanner in the works last Monday, this time about the so-called stability pact. Earlier, at German insistence, this pact had been hammered out to ensure fiscal discipline on the part of the participating countries, post-EMU. The treaty is due to be ratified in the European union summit which begins in Amsterdam today. Last Monday the new French finance minister stated that his government had not had enough time to examine the treaty, and the ratification may have to be delayed. France may also seek greater flexibility in the terms of the stability pact.

In retrospect, the problems have arisen by overfocussing on the magic three per cent, as it fhte sucess or failure of EMU depends on Germany's or any another country's fiscal deficit for 1997 being 2.9 per cent or 3.1 per cent of GDP!

Be that as it may, as of now, it is a reasonable bet that, barring a major impasse in today's summit, EMU will go ahead as scheduled, the looser interpretation of the Maastricht criteria being used to decide on participation. The financial markets seem to believe so, for the surprises in France and Germany have had very little impact on intra-European currency corsses or bond yield. To be sure, European currencies, including the mark, have softened against the dollar. But keep your fingers crossed. The European central bank, if and when it comes into being, may well adopt a tougher monetary policy that it otherwise would have, if only to establish its credibility and a stable euro. No wonder politicans in France (and elsewhere) are itching to have a say in how the ECB will be run. A new currency leading to even higher unemployment is hardly a prospect they could relish!