Germany warned on deficit

January 30, 2002 Posted: 1411 GMT

LONDON (CNN) -- The European Commission has recommended Germany and Portugal be formally warned that their budget deficits are close to exceeding EU limits.

It marks the first time the commission has called on European Union states to warn other members about budget deficits, since the Stability and Growth Pact was adopted in 1997.

Under the pact, approved at the insistence of Germany, member states must keep deficits below 3 percent of gross domestic product, or face the risk of fines.

Germany's deficit rose to 2.6 percent of its GDP in 2001, compared to a forecast of 1.5 percent. Portugal's deficit reached 2.2 percent last year, up from a forecast of 1.1 percent.

"In the commission's view, an early warning should be issued to Germany and Portugal," said EU Monetary Affairs Commissioner Pedro Solbes told a news conference. "The situation is sufficiently serious." 

EU finance ministers will meet on February 12 to decide whether to approve the commission's recommendation.

Germany, Europe's largest economy, is of particular concern to the commission, as it believes the country's budget deficit will continue to rise – likely reaching 2.7 percent this year.

"It is an irony of history that Germany was once the country imposing the stability pact," Hans Redeker, an analyst at BNP Paribas, told CNN. "It was worried that other countries would derail the success of the euro... Now it's Germany itself that looks likely to be the culprit."

The stability pact was aimed at ensuring the new single currency would remain strong by preventing over-spending by member countries, such as Italy. But the global economic downturn has turned attention to former powerhouses, such as Germany.

Faced by the threat of recession, the government is in the predicament of having to spend money to help re-ignite economic growth while at the same time being restricted by EU budget limits. The government also has to deal with aggressive wage demands from the country's strong trade unions.

Germany's gross domestic product grew by just 0.6 percent last year, compared to a 3-percent expansion in 2000. It was the lowest annual growth rate since 1993, when the economy shrank 1.1 percent.

While the Federal Statistics Office did not provide figures for the fourth quarter of last year, many economist believe the economy contracted by 0.5 percent in the last quarter  – meaning Germany had technically slipped into recession.

Meanwhile, German unemployment has been increasing over the last 12 consecutive months – rising in December to 3.964 million from 3.789 million the previous month. The unemployment rate edge up to 9.6 percent in December from 9.2 percent in November.

Inflation has also been rising, reaching 2.4 percent in 2001, up from 2.1 percent the previous year and 0.6 percent in 1999.

These mounting economic pressures may prompt the European Central Bank to start raising interest rates again.

"The ECB is on alert. They are worried about wage negotiations in Germany and future inflation from that," Anais Feraj, an economist at Nomura International, told CNN.

"They are also worried about the stability pact. If they see deficits rising, that is a good enough reason for them to start raising interest rates ahead of time. That is the last thing now that the eurozone economy needs."