Fetish figure that threatens the single currency

'The French and German governments tried both fudges and austerity, claiming Maastricht required such action. In the process they succeeded in linking the single currency with recession in voters' minds - an association which could still prove the death knell for the treaty'

The scheduled 1999 start date for the euro is looking increasingly rocky under the impact of twin blows from the French electorate and the German Bundesbank in the past few days. Yet if the Maastricht convergence criteria were interpreted sensibly, as the drafters of the treaty originally intended, then many of the latest difficulties would disappear. It is not too late for European politicians to realise this, and to start talking common sense on this subject, instead of just mouthing meaningless numbers from Maastricht.

On the face of it, the obstacles to the scheduled start date now look formidable. Just as the French have become minded to ask for a looser interpretation of the Maastricht convergence criteria, and for a renegotiation of the Stability Pact, the ability of the Kohl government to make concessions has been heavily circumscribed by its debacle over the Bundesbank's gold reserves.

This is a very menacing combination. It remains to be seen whether the Jospin government will choose to keep its new demands within the confines of what can be agreed by the Bundesbank. If it does not, then delay or cancellation of the project will become possible - as British politicians (always hoping to dance on the grave of Maastricht) have eagerly pointed out this week.

But some of these headaches are really quite unnecessary. They stem from an over-rigid interpretation of the Maastricht budget criterion - an interpretation which has looked politically convenient in several countries for the last couple of years, but which now threatens the entire project. This is how the problem arose.

When the treaty was first drafted, it was recognised that the existence of a single currency would carry inevitable implications for budgetary policy, and that this would require some form of supra-national policing of the fiscal stances of the member states.

The reason for this is compelling. Once inside a single currency, members would be able to finance budget deficits at a common rate of interest, and under certain circumstances this could mean that highly indebted countries would be able to lean on the creditworthiness of their fellow member states in order to hold down their own borrowing costs.

In order to prevent this "free rider" problem from getting out of hand, the treaty requires that, to qualify for membership of the single currency, countries must show that they have attained "sustainable" budget positions. This means that they must be in a position where their budget deficits are low enough to stabilise their public debt ratios at a prudent level.

So far, so good. No one with the slightest understanding of economics could object to this requirement. And no country with a sustainable budget position (eg Germany) would enter a monetary union with another member state (eg Italy) unless it could be confident that the political system of the latter was capable of delivering a sustainable budget position for the indefinite future.

However, in a search to avoid the need for subjective judgments when the final membership came to be assessed, the drafters of the treaty attempted to define in numerical terms what a sustainable budget position might involve. Among other things, they suggested that it should ideally involve a debt ratio of under 60 per cent of GDP, and a budget deficit of under 3 per cent of GDP. The 60 per cent debt ratio was arbitrarily set at the level which the EU happened to exhibit at the time, and the budget limit was set to correspond to this figure. But just in case anyone should take such arbitrary figures too seriously, the treaty included a number of hedge clauses which were intended to allow subsequent wriggling room, should it be needed.

Unfortunately, however, the German Finance Minister, Theo Waigel, decided to take the 3 per cent limit for the budget deficit absolutely literally, and also to apply it to the 1997 calendar year outcome (which had never been mentioned at all in the treaty).

He did this for a simple reason. Towards the end of last year, it appeared likely that Germany and France would be able to reduce their budget deficits to below 3 per cent of GDP in 1997, but that Italy would not. Since the Germans felt that it would be politically impossible to sell a monetary union to their own electorate if Italy were included, they alighted upon the 3 per cent limit as an "objective" way of keeping the Italians out of the first round. Dr Waigel went around chanting his "3.0 per cent means 3.0 per cent" mantra, and for a while it became deeply unfashionable to point out that such a literal interpretation of the budget limit was completely contrary to the letter and spirit of the treaty.

This convenient piece of political-speak, however, has badly backfired. As the recession has dragged on in both France and Germany, it has become apparent that the 3 per cent budget limit could not be hit in 1997 without either a series of budget "fudges", or some genuine austerity measures which were entirely inappropriate in the economic circumstances.

Governments tried both fudges and genuine austerity, claiming that Maastricht required such action. In the process, the same governments not only brought themselves into disrepute with their electorates, but succeeded in linking the single currency with recession in the voters' minds - an association which was quite unnecessary, and could still prove the death knell for the treaty.

This association was unnecessary because the treaty had clearly foreshadowed that the 3 per cent limit could be waived in case of recession, both by saying that the structural (ie cyclically adjusted) deficit could be taken into account, and by saying that the future prospects for the deficit are as important as the outcome in any given year. The single currency does not need to spell austerity and recession - it is just the politicians who have chosen to make it so.

It would always have been open to the Germans and French - and indeed it still is - to make the following statement: "Germany and France both have sustainable budget positions, as defined by the treaty, notwithstanding the fact that our deficits will exceed 3 per cent of GDP in 1997 for cyclical reasons.

"Both countries have demonstrated over many years that our political systems can maintain this situation. Despite the Herculean efforts of the Prodi government, Italy has not yet demonstrated as much, though significant progress is being made. We therefore intend to proceed to monetary union on time, with Italy hopefully following shortly thereafter."

Probably the UK would call this a "fudge", but it would not be one. Instead, it would be an adult statement of reality, the kind of reality on which countries should really decide whether to form monetary unions with one another. Encouragingly, Wim Duisenberg, who shortly becomes head of the European Monetary Institute, said on Friday that the 3 per cent budget limit was a "fetish", and that what mattered was whether budgets were broadly moving in the direction of sustainability.

Exactly. If France and Germany have the will to follow this line, then the 1999 start date can still be rescued - though, if Lionel Jospin is serious about the inclusion of Italy from the start, then it is hard to see how this formula, or indeed any other, can accommodate his wishes.