The European Union's executive body has given Germany, the bloc's biggest member, a stark warning: either it gets its budget deficit under control, or it faces severe penalties.
The European Commission Wednesday told Germany that it must take meaningful steps to cut its budget deficit, which the commission says surpasses the limit set for the 12 countries that use the euro, the European single currency.
The irony is that Germany was the main architect of the EU's stability and growth pact, which sets budget deficits at three percent of gross domestic product. The idea behind the strict limits was to prevent the euro from being weakened by governments that spend too much.
European Monetary Affairs Commissioner Pedro Solbes told reporters in Brussels that Germany's deficit reached 3.75 percent in 2002 and risks exceeding the target again this year. Speaking through an interpreter, he recommended that the Council of EU finance ministers, which meets later this month, give Germany until May 21 to bring the deficit under control or face heavy fines, as called for in EU treaties.
"The commission is recommending to the council to decide that an excessive deficit exists in Germany," he said. "With growth prospects not improving, there is a risk that Germany will exceed the three percent of GDP reference value in 2003, too."
Mr. Solbes expressed skepticism about the German government's prediction that it will bring the deficit within the EU limit this year. He said a potential war in the Middle East and rising oil prices make such forecasts uncertain. And he notes that German consumer spending is already stagnating.
Store owners in Germany say customers are showing a reluctance to part with their money despite massive post Christmas price reductions. People are buying less and are even postponing or canceling vacation plans. Four million people are jobless, and the payment of generous unemployment benefits to so many people is pushing the government's budget further into the red.
Chancellor Schroeder now faces a tough decision on how to deal with the budget deficit. Conventional wisdom would indicate that he should raise taxes and cut public spending. But economist Holger Schmieding, of the Bank of America in Frankfurt, said those steps could make an already severe economic downturn even worse.
"The fiscal tightening is really what the German government cannot do or should not do," Holger Schmieding said. "So what I hope the German response to this request will be (is) not a tax hike, no major cuts in expenditures right now, but a credible program for structural reform, which, over the long run, would help to improve the German budget a lot."
The European Commission, the European Central Bank and several economic analysts have called on Mr. Schroeder to move faster to loosen Germany's tightly regulated job market, overhaul its expensive social welfare system and reduce red tape for business.
But the chancellor faces a more immediate threat than EU sanctions: an all out strike by firefighters, garbage collectors, nurses and other public sector workers who are demanding a three percent pay raise.
Economist Hans Redeker, of BNP Paribas in London, said Germany cannot afford such a strike.
"Germany is still the weakest link in Europe, and there are no signs whatsoever that they can get out of this situation," he said. "And the wage claim in the public sector, if they really were to get three percent in the end, would be more bad news for the government and the country."
German officials said the European Commission has failed to take into account the enormous amount of money the government must still spend to bring the formerly communist eastern part of Germany up to Western levels. But EU officials worry that if Germany, the biggest European economy, is in trouble, so is the whole of Europe. And that, they say, is hardly likely to enhance the image of the euro as a strong currency.
Commissioner Solbes said he does not foresee any immediate fines for Germany. Gwyn Hacche, an analyst for HSBC in London, said it is unlikely that Germany will be fined at all.
"For one thing, the whole procedure can take a very long time," he said. So that, even though it's being threatened at the moment, the actual fines wouldn't be paid until something like four years down the road.
"But I think, ultimately, the decisions about the fines will be made by the politicians, by the euro-zone finance ministers," Mr. Hacche continued. "And I just wonder whether countries like France and Italy would be prepared to vote for fines on Germany, given that they are so close to be fined themselves."
The European Commission has chided France and Italy over their deficits, too, saying France risks breaching the EU's three percent threshold this year by cutting taxes and raising spending. The commission also warns that Italy's plans to stay within an agreed budget limit only partly comply with EU guidelines. Officials of both countries have indicated that they will proceed with their plans despite the EU warning.