Could Floods Make their Way to Maastricht?

In what is perceived by many political experts as a big gamble, Chancellor Gerhard Schröder earlier this week postponed tax cuts that had already been approved for January in order to release funds for emergency relief in flood-swept eastern Germany.

The tax cuts that were due to have come into effect in 2003 would have saved taxpayers as much as seven billion euro. The tax reform package was the centrepiece of Chancellor Schröder’s economic policy after four years in power.

But with the damage from the floods already estimated at some 10 billion euro, the government is worried about breaching the strict borrowing limits for euro zone members laid down in the Maastricht Treaty of 1993.

Announcing a freeze on additional public spending, Finance Minister Hans Eichel said earlier this week that the size of Germany’s budget deficit ruled out funding the flood damage by increasing government borrowing.

Germany, the euro zone’s largest economy, is expected to run a deficit of 2.7 percent this year, dangerously close to the three-percent ceiling on member country borrowing. Though Eichel made it clear that Germany would stick to the Maastricht criteria, he said it would be "a close shave".

Budget must be below three percent

The stability and growth pact signed by EU member states in 1996 is an add-on to the Maastricht treaty of 1993 that formulated the criteria for the introduction of the common currency, the euro, in participating member nations.

According to the treaty, the inflation rate of a member country is not allowed to surpass two percent and government debts can reach a maximum of 60 percent of gross domestic product. One of the central conditions of the treaty is that the budget deficits of states in the euro zone are not allowed to exceed three percent.

To ensure this, members states must show the European Commission and council a yearly stability and growth programme that provides detailed information about their budgets.

Natural catastrophes allow for exception

However, the European Commission has the right to make an exception in the case of natural catastrophes or extremely high recession.

The stability and growth pact allows for exemption from punishment when a member country crosses the three percent mark in the event of an "extraordinary situation" that requires the full attention and resources of the country.

Can Germany honour its EU budget commitments?

Within the EU, Germany along with Portugal, is still viewed with watchful eyes after it narrowly avoided a "warning letter" from the EU earlier this year to rein in its ballooning budget deficit.

Despite the assurances from Eichel, a growing number of voices in Germany are now asking whether it is realistic to adhere to the treaty under present circumstances.

"We don’t know how high the flood damages will turn out to be", a spokeswoman of Eichel’s Finance Ministry told the "Financial Times Deutschland" newspaper on Monday. "That’s why we can’t say whether we will surpass the Maastricht borrowing limits or not".

Rolf Peffekoven, financial analyst in Mainz, told the German news agency Deutsche Presse Agentur that if financial aid reached several billion euro, it would definitely threaten Germany’s adherence to the Maastricht treaty.

He fears that the flood costs would now be used to defend a possible crossing of the three-percent mark. "I consider it extremely dangerous that for some time now even in Germany there have been discussions on how one can get around the stability and growth pact", he said.

Floods take priority for Schröder

Chancellor Schröder has so far been non-committal about the discussion regarding Germany’s adherence to the Maastricht Treaty.

He has been quoted as saying that the EU budgetary goals don’t interest him in the face of the drastic situation in the east. Even Economics Minister Werner Müller and Interior Minister Otto Schily said last weekend that the budget deficit has no priority under the present circumstances.

The government’s decision to postpone tax cuts has received a mixed reaction from the business community and economists.

The Federation of German Industries (BDI) and the Association of German Chambers of Industry and Commerce (DIHK) said they would support the decision in a show of support for flood victims, although the postponement "was, in effect, a limited tax increase".

Karl Brenke, a finance expert from the German Insitute for Economic Research (DIW) in Berlin, told DPA he doesn’t see the danger of a "warning letter" from Brussels. The Maastricht Treaty clearly makes exception for the crossing of the stability border in the case of extraordinary situations, he said. "Such weather catastrophes fall in that category", he said.

Fears of Italy cashing in

Meanwhile there are fears that other European countries such as Italy could cash in on Germany’s present troubles in meeting the conditions of the stability and growth pact to push a loosening of the Maastricht standards.

The Austrian government has already questioned its commitment to the EU budgetary goals as it grapples with flood damages of about four billion euro.

Italy’s Umberto Bossi, party leader of the governing Liga Nord party said in a statement, "now we must postpone the current commitment towards the stability and growth pact by four to five years".

Brussels concerned about Germany's commitments

Over the past few days concern has been growing among European Commission officials that Berlin could blame the cost of the floods for its failure to keep its deficit below three percent.

Commission president Romano Prodi, last Friday warned flood-stricken Germany that despite huge flood aid, Germany should not falter in its commitments to the euro stability and growth pact.

But Brussels has now welcomed Germany’s move to postpone tax cuts, saying it would enable Germany to pay for the damages without breaching its Maastricht commitments.

Pedro Solbes, the EU's economic affairs commissioner, said in a statement on Tuesday: "The decisions of the German government show that national governments can react efficiently within the framework of the European stability and growth pact".