Commission backs down over debt limits in eurozone

The first big changes to strict rules governing the euro are to be proposed in a tactical retreat by the European Commission after months of conflict with member states over their economic management.

The move marks the first formal recognition of flaws in the Stability and Growth Pact that lies at the heart of the European single currency.

Officials in Brussels are drawing up guidelines to allow governments with sound economies more flexibility to borrow for investment and to focus on growth.

The plans are likely to be welcomed by Britain, which despite being outside the euro has argued with Brussels over levels of borrowing to fund investment. But they would not affect the position of countries judged to be straying from basic commitments ­ and might not be enough to appease several member states who have been critical of the way eurozone rules operate.

Germany, France, Italy and Portugal believe the way Brussels interprets the Stability and Growth Pact gives governments insufficient leeway in periods of low growth.

Countries can be fined if their budget deficit exceeds 3 per cent of gross domestic product. The European Commission says that it will start its first formal proceedings against a eurozone country if there is official confirmation that Portugal's 2001 deficit has hit 3.9 per cent. Although fines are unlikely to be levied against Lisbon, the issue has highlighted tensions among eurozone countries.

France and Italy are increasingly at odds with the EU commissioner for economic and monetary affairs, Pedro Solbes. Britain has also had a series of rows over the Commission's criticism of UK borrowing, which is designed to help boost investment in infrastructure. The guidelines, which will be presented in the autumn, will probably deal with the objections raised by the Chancellor, Gordon Brown.

A spokesman for Mr Solbes, Gerassimos Thomas, has rejected criticism that the pact is too rigid. "There is flexibility. It is probably a good idea to codify this flexibility," he said. The guidelines would take more account of the economic cycle and the extent of investment addressing structural problems.

A Treasury spokesman said the Government would "welcome any move towards our prudent interpretation of the stability and growth pact but we do not yet know what this means".

The new guidelines might be designed to help shore up the position of the Commission, which was humiliated this year when its attempts to deliver a formal warning to Germany over its rising deficit were thrown out by EU finance ministers.

If it could get agreement on more specific guidelines laying down when governments should be permitted to spend more it would reduce the potential for finance ministers to dispute the Commission's thinking.

Chris Huhne, economics spokesman for the Liberal Democrat group in the European Parliament, said: "The problem with the pact is that it is simply too crude and too ambiguous to be an instrument of discipline."