July 13, 2004 - 4:00 PM

EU court annuls budget verdict

By Lisa Jucca and Swaha Pattanaik

LUXEMBOURG/BRUSSELS (Reuters) - The European Union's highest court has annulled a
decision taken last year by the bloc's finance ministers to suspend disciplinary action against Germany
and France for excessive budget deficits.

But the nuanced court ruling had enough in it to be welcomed in Berlin while French Finance
Ministry Nicolas Sarkozy said on Tuesday it would spur his efforts to control public spending.

Last year's decision to spare the blushes of the two largest euro zone countries for having exceeded
a three percent of gross domestic product budget deficit ceiling dented the credibility of EU rules
designed to underpin the euro single currency.

It was challenged by the European Commission, guardian of the Stability and Growth Pact which
sets these rules out.

The European Court of Justice said ministers had the right to change Commission
recommendations on budget policy but that they had failed to respect the rules when they suspended
disciplinary action against Germany and France.

The two countries are expected to break the EU deficit cap for the third year running in 2004 and
the Commission had recommended that ministers tell Germany and France to take steps to bring their
deficits below the limit in 2005.

The Commission welcomed the ruling, which was seen strengthening its hand at a time when it
expects six of the euro zone's 12 members to run 2004 budget deficits above the EU cap.

"The council tried to sidestep the process and came up with a political compromise but the court
said they must follow the rules of the game," said William Robinson, partner at Freshfields Bruckhaus
Deringer in London, where he is a member of the EU group dealing with dispute resolution.

"This is a brave decision that upholds the rule of (procedural) law. The Council (of ministers) will be
horrified, but the Court has simply held them to their procedural bargain."

Excessive deficit procedures may now be restarted against Germany and France but analysts said
they need not fear fines, the ultimate sanction in the budget disciplinary procedure.

"The credibility of the Stability Pact is pretty much shot to pieces as there have been abuses left,
right and centre. Moreover, it is clear that there will always be a way out of fines," Nick Eisinger,
director in Fitch's sovereign ratings group, told Reuters in a telephone interview.

Indeed, Germany's finance ministry welcomed the court ruling, saying it had confirmed that finance
ministers do not have to follow Commission recommendations when disciplining governments.

"On the central issue the court has confirmed the legality of the Council's decision of November 25,
2003," a ministry spokesman said.

France's Sarkozy was also sanguine. "This decision boosts me in my commitment to reduce the
deficits, which is in line with France's European commitments," he said in a statement.

However, Austrian Finance Minister Karl-Heinz Grasser urged the Commission to set a new
deadline for Germany and France to cut their deficits to comply with the rules.

"The Commission can do nothing other than declare Germany and France in default," he told
Reuters in an interview. "The Commission should set them a new deadline for getting back under
three percent and tell them what measures to take."

FOCUS ON CHANGE

The court decision provoked little immediate reaction in financial markets.

"This is bond positive as the European Commission is in a stronger position and we could expect a
tighter fiscal policy in countries like France and Germany and less government bond supply," said
Kornelius Purps, fixed income strategist, Hypovereinsbank.

"Nevertheless, the discussion that will take place in the coming weeks will be more academic than
market moving."

Eisinger at Fitch said the focus should now be on the need to revamp the Stability Pact -- a project
on which the Commission is already working.

"It illustrates that the Stability and Growth Pact is a model that needs some adjustment and people
realise that already," he said.

The EU executive has already said some elements of the pact are too rigid and presented ideas for
improving its application.

Among these was the suggestion that the scope of a crucial get-out clause could be widened to
introduce more flexibility.