Special Report No 1/89 on the agrimonetary system accompanied by the replies of the Commission
Date: 1989-03-30
Institutions: European Court of Auditors
Subjects: agricultural product, extra-EU trade, fixing of prices, intra-EU trade, monetary compensatory amount, representative rate













EUR-Lex - 31989Y0524(01) - EN






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31989Y0524(01)

Special Report No 1/89 on the agrimonetary system accompanied by the replies of the Commission  


Official Journal C 128 , 24/05/1989 P. 0001 - 0039 





SPECIAL REPORT N° 1/89 on The agrimonetary system accompanied by the  replies of the Commission (89/C 128/01)(Observations pursuant to Article 206 (a) paragraph  4 of the EEC Treaty)>TABLE>1. INTRODUCTION1.1. This report records the  results of an examination by the Court of Auditors of the agrimonetary system. It places particular  emphasis on the consequences for the general budget of the system, and the extent to which it  interferes with the sound management of the common agricultural markets, which provide the basis  for the functioning of the common agricultural policy (). To aid the reader, a glossary is included  in Annex VII. Common market organizations and common prices1.2. In order to ensure freedom of trade it was  originally envisaged by the Council () that the level of prices in each currency would remain the  same in ECU terms. This meant that the common prices set by the Council in ECU would be converted  into national currencies by the application of agricultural conversion rates (known as green rates)  which would normally be the same as the market rates of exchange. Any adjustment in market rates of  exchange would be accompanied by equivalent changes to the green rates, to keep them in line with  the market rates. 1.3. However, on the occasion of the first changes in currency parities after the introduction of  common prices into the CAP, the principle of the unity of prices was breached. In 1969 when the FF  was devalued and the DM was revalued, the Council allowed green rates and market rates to diverge.  Monetary Compensatory Amounts (MCA's) were introduced to fill the gaps, in order to try to preserve  the effects of the pre-existing common price system in the operation of the intervention  arrangements and in enabling trade to continue at a common price level. 1.4. The objectives of monetary compensation, as set out in the current regulations, emphasize the  need to preserve the functioning of the common agricultural markets, including freedom of trade.  The regulations state: (a)in order to avoid jeopardizing the proper functioning of the market organizations in general and  the intervention system in particular, and to avoid difficulties caused by abnormal changes in  prices and artificial movements in trade flows, a system of monetary compensatory amounts should be  applied in trade bridging the gap between the market rate and the agricultural conversion rate;  this is further qualified by; (b)monetary compensatory amounts must be paid or charged only where their absence would engender  distortions in the intervention system and/or in trade; (c)monetary compensatory amounts must be kept down to the levels strictly needed to offset the  impact of the gap between the agricultural conversion rate and the market rate on the price of  basic products for which intervention measures have been laid down (). 1.5. The agrimonetary system has undergone a number of modifications, most notably in 1984 with the  introduction of the green ECU and the switchover mechanism (see below paragraph 2.8) and most  recently in 1987 when Council decided to retain the switchover mechanism and to introduce, by means  of regulations, arrangements for automatically dismantling new MCA's created in the future (see  paragraph 2.9). This is intended to be a step towards the gradual elimination of the system by  1992, when, in line with the current programme, the single market is to become effective. Objectives of the Court's enquiry1.6. The purpose of the Court's enquiry was: (a)to evaluate the extent to which the agrimonetary system - both before and after the introduction  of the switchover - interferes with the sound management of the common market organizations, in  particular by its impact on common prices; (b)to evaluate the budgetary impact of the agrimonetary system, and the way in which that impact is  presented in the budget and the revenue and expenditure accounts of the Community. 1.7. The Court's examination, which included missions to France, the United Kingdom and the FR of  Germany, did not include a detailed audit of Member State management and control systems. These  systems are operated by the customs authorities and paying agencies in the Member States, and to a  considerable extent are the same systems as those used for the collection of agricultural levies  and the payment of export refunds. As such, these systems are the subject of other detailed audits  carried out by the Court (). Summary of results1.8. The results of the Court's examination can be summarized as follows: (a)the annual decisions of the Council fixing the level of agricultural prices in ECU do not  reflect real developments in institutional prices: following each EMS realignment the application  of the switchover mechanism to avoid the creation of positive MCA's in effect raises the common  price level in line with the strongest currency in the EMS, the DM. These increases in the common  price level, however, are essentially hidden (paragraphs 4.1 - 4.8). The impact of these hidden  price increases feeds through as increased budgetary expenditure in a manner that is obscure  (paragraphs 6.11 - 6.18). The switchover, therefore, has not improved the management of expenditure  in the agricultural markets. It has, also, resulted in the exchange rates used for agricultural  purposes becoming further removed from real exchange rates (paragraphs 4.2 - 4.3); (b)the budget and accounts give only an incomplete picture of the impact of the agrimonetary system  on the budget: for example, instead of the 636,9  Mio ECU recorded in chapter 28 of the EAGGF  budget for 1987, the Court has assessed the full impact on the combined revenue and expenditure  budget at at least 1  578,2  Mio ECU (10-month basis) and 1  824,6  Mio ECU on a full 12-month  basis. This is equivalent to 7  % of EAGGF expenditure (paragraphs 6.2 - 6.22). By far the largest  element of this results from the hidden increases in the common price level caused by the  switchover mechanism. Interpretation of the data in the accounts is made very difficult by the fact  that the impact of the agrimonetary arrangements, including the switchover, are not adequately  identified. The situation described above means that without detailed knowledge of the impact of the  agrimonetary system, it is not possible either to understand fully the real meaning of the annual  agricultural price fixing decisions, or to interpret the accounting information presented by the  Commission. 1.9. The existence of green rates that diverge from market rates and the resultant monetary  compensation arrangements are an impediment to the creation of a genuine common agricultural market  in the Community. As the Commission has stated (), the agrimonetary system is inconsistent with the  concept of the single European market which is to be achieved by 1992. Failure to abolish the  agrimonetary system will mean that Community agriculture will continue to be protected from the  laws of supply and demand, as measured by real exchange rates, which determine levels of economic  activity in other sectors of the economy and which provide the basis for the single European  market. However, abolition of the system presupposes agreement on a genuine common price level, a  closer degree of monetary convergence between the Member States and a weakening of the role of  agricultural support prices in determining market prices. Without this, it is unlikely that the  target of a genuine common agricultural market will be achieved. 2. CONCEPTUAL FRAMEWORK OF THE AGRIMONETARY SYSTEMRegulatory framework2.1. As  the agrimonetary system has developed, it has been necessary to develop a framework of regulations  to govern its application. These regulations have been subject to frequent amendment. In 1985,  following the introduction of the switchover mechanism, the latest set of regulations was issued.  These are listed in Annex I. Green rates and monetary gaps2.2. The European Monetary System (EMS), with the ECU as its currency  unit, provides the monetary background to the system of green rates and MCA's. This is explained  further in Annex II. 2.3. To maintain a genuine common price system between Member States, with prices in each Member  State's currency having the same equivalent value in ECU, it would be necessary for green rates to  follow fluctuations in central and market rates of exchange. However, ever since the first  modification to currency parities after the introduction of common prices, Member States have not  been prepared to accept the consequences of this for institutional prices and aids in national  currency. In the case of a Member State whose currency had been revalued, these prices and aids,  though unchanged in ECU, would fall, at the new rate, thus bringing about a fall in agricultural  revenues. In the case of a Member State whose currency had been devalued, the ECU amounts in  national currency would rise, increasing agricultural incomes, but also putting inflationary  pressure on prices to consumers. 2.4. Member States have, therefore, sought to cushion the impact of currency movements on  agriculture by delaying the adjustment of the green rates to the new real parities, maintaining the  value of institutional prices in national currencies at their former levels. As a result, monetary  gaps have opened between green and markets rates of exchange. Annex III describes how these gaps  are calculated. The objective has been to realign progressively the green rates with the real rates  as the economic impact of the currency realignment works through to the agricultural sector. It has  not, however, always been possible to complete this adjustment process before new realignments have  opened new monetary gaps between the green rates and real rates. 2.5. If nothing were done to cover the monetary gaps, there would be immediate consequences for the  operation of the intervention mechanisms and for trade flows. For example, an operator in a Member  State whose prices in national currency were below the common price level (e.g. France, with a  depreciated currency) would obtain higher prices by selling into intervention in other Member  States whose prices were above the common price level (e.g. FR of Germany, with an appreciated  currency) and converting the foreign currency obtained into their own currency at the market rate.  Similarly, imports into the Community would be channelled through Member States where agricultural  levies were expressed in national currency at prices below the common price level, and exports to  third countries would be channelled through those Member States where the refunds were expressed in  national currency at prices above the common price level. Monetary compensatory amounts2.6. Thus, in order to minimize the impact on the intervention system  and trade flows, and to preserve some of the appearances of a common price system, the agrimonetary  regulations provide that, where green and market rates of exchange are different, MCA's broadly  covering the gap shall be applied. For Member States where the green rates are below the market  rates (i.e. whose prices in national currency are above the common price level) the MCA is applied  as a levy on imports and a subsidy on exports, and is called a positive MCA. For Member States  where the green rates are above the market rates (i.e. whose prices in national currency are below  the common price level) the MCA is applied as a subsidy on imports and a levy on exports and is  known as a negative MCA. Application of MCA's2.7. Although the system of green rates applies through all the market  sectors, the existence of a monetary gap does not necessarily lead to compensation. The principle  underlying the application of MCA's is that they should only be paid or charged 'where their  absence would engender distortions in the intervention system and/or in trade` (). Where  intervention arrangements do not exist, or where there is no perceived risk of trade disturbance  despite the existence of a monetary gap, MCA's are not applied. Table 1 lists the markets where  MCA's are applied. >TABLE>The green ECU and the switchover mechanism2.8. Experience since the introduction  of MCA's in 1969 shows that it is extremely difficult to dismantle the positive monetary gaps for  Member States with appreciated currencies because of the reduction in prices in national currency  that this entails. The 'Gentlemen's Agreement` approved by a majority of the Council Members in  March 1979, which provided that any reduction in MCA's should not lead to a reduction in prices in  national currencies, combined with an increasingly restrictive pricing policy adopted as the  problem of surplus production became more serious, in effect institutionalised what was already  reality. In 1984, therefore, a device was introduced which aimed to circumvent the problem by  'switching` positive MCA's into negative ones, and avoiding the creation of new positive MCA's in  the future for the fixed rate currencies. How this device works is shown in Figure 1 and described  in Annex  IV. The key element in the arrangements is the application of a correcting factor to the  central rates of those Member States' currencies which are in the Exchange Rate Mechanism of the  EMS and to the notional central rates used for the floating rate currencies. Automatic dismantling of MCA's2.9. As part of the 1987/88 prices package, adopted in June 1987,  Council agreed on automatic arrangements for dismantling new MCA's created at future currency  realignments. These arrangements do not apply to MCA's already existing at the time of the  decision. The detailed provisions () are set out in Annex IV. 2.10. The decisions of June 1987 concerning new MCA's were supplemented by decisions taken in June  1988 by the Council as part of the 1988/89 price fixing to dismantle the remaining negative MCA's  of the narrow-band EMS Member States (Belgium, Denmark, France, Ireland, Luxembourg) in four stages  leading up to 1992, starting with a dismantling of about 25  % on 1 January 1989. A commitment was  also made to dismantle the monetary gaps for Italy and the remaining four Member States with  variable MCA's (Greece, Spain, Portugal, United Kingdom), but no details were fixed. 2.11. The objective of these two sets of decisions is to achieve the full dismantling of all the  real monetary gaps by 1992. This could be achieved if the decisions are fully applied, the  commitment in respect of the variable MCA countries and Italy is followed through, and there are no  monetary disturbances in the years leading up to 1992. Any realignment after the beginning of the  1990/91 campaign year will mean that monetary gaps will be carried through into 1993. 3. THE IMPACT OF GREEN RATES ON THE SYSTEM OF COMMON PRICESVariations in  common price levels3.1. When green rates diverge from market rates, the value of the common ECU  farm prices when converted into national currencies varies from one Member State to another. The  common price level, therefore, differs from one Member State to another, and is, therefore, no  longer truly common. The extent of the variation in common prices, which is measured by the real  monetary gap between the green and real rates, has varied considerably during the life of the  agrimonetary system, and between Member States. At certain times the gaps have been small for most  Member States whereas at others the gaps have been wide. In 1978, for example, the combined real  monetary gap between French and German green rates was over 25  % for much of the year: thus the  level of institutional agricultural prices in national currency in the FR of Germany was 25  %  higher than in France. At the time of the introduction of the switchover in 1984 the difference was  about 17  %. 3.2. Following the agrimonetary decisions which formed part of the 1987/88 and 1988/89 price fixing  agreements, the monetary gaps have been considerably narrowed in most Member States, and with it  the differences in price levels between the Member States have been reduced. As is shown in  paragraphs 4.5 - 4.6, the convergence is on the price level in the FR of Germany. 3.3. In addition to the variations in common prices between Member States, since 1984 there has  been an increase in the number of different green rates for different market sectors within Member  States. This differentiation of green rates, however, is not the same in each Member State. Thus,  in March 1988, for example, the FR of Germany had three different green rates in operation (milk,  cereals, all other products). France had six green rates (milk, pigmeat, beefmeat/sheepmeat, other  animal products, wine and other vegetable products), the United Kingdom five green rates (pigmeat,  beefmeat, sheepmeat, other animal products, all vegetable products), and Italy three different  rates (pigmeat, cereals/oil seeds, all other products). 3.4. The variations in the common price level between Member States and between markets within  Member States have a number of implications: (a)they raise the question of the extent to which Member States are able to use the system to  pursue national pricing policy objectives which may not be consistent with Community objectives for  the functioning of common market organizations; (b)differing price levels would be expected to affect the allocation of resources in agriculture; (c)there are direct budgetary consequences. The direct budgetary consequences are examined in detail in chapter 6 of this report. The other two  implications are considered in the following paragraphs. Green rates and Member States pricing policy3.5. Formally, green rate changes are decided by  Council on the basis of a proposal by the Commission. Normally green rate changes are decided once  a year as part of the price fixing decisions (). This means that individual Member States, by  negotiation, are able to exert considerable influence over the level of their green rates and thus  to keep an important degree of national control over the internal level of their prices. 3.6. At certain times the interest of the Member States has been to resist pressure to dismantle  monetary gaps. In the case of positive gaps this is because the national priority has been to avoid  reductions in the incomes of its producers (e.g. FR of Germany, United Kingdom between 1980 and  1985), in the case of negative gaps it has been because the Member State's priority was to avoid  increasing food prices (e.g. United Kingdom in the 1970's and 1986 to 1987, France in the early  years of the agrimonetary system). 3.7. In other cases, Member States with negative monetary gaps have sought special treatment for  particular groups of producers by selective devaluation of the green rates. This has been  particularly so when Member States have sought to alleviate the effects of a restrictive ECU prices  policy, securing price increases in national currency by means of green currency adjustments. For  example, in 1986 and at the beginning of 1987 monetary gaps were reduced more for animal products  than for cereals products because farmers' net returns were considered to be under greater pressure  in the animal products sector, while similar price increases for cereals producers could not be  justified. 3.8. In the 1988/89 price fixing the Commission's initial proposals for limited dismantling of  Greek monetary gaps only were not accepted by a number of Member States with negative gaps. They  sought, and eventually obtained, a much greater degree of dismantlement of their own gaps. One  specified objective was to achieve progress towards the goal of full dismantlement by 1992, but it  was also clearly stated in the arguments of the Member States concerned that they were seeking  higher prices in national currencies for their producers at a time when common prices in ECU were  being frozen for a further year. 3.9. Table 2 and Figure 2 show that since 1984 Member States have been able to obtain price  increases in national currency by means of green rate changes while common price increases in ECU  have been restrained. For EUR 10 common prices in ECU have fallen marginally after the increase in  1983/84, but, following green rate adjustments, they have continued to rise significantly in  national currency in nominal terms in each year. For some Member States the nominal price increases  in national currency have been considerable: leaving to one side the special case of Greece, which  is affected by the adjustments in price levels made following accession, France, Ireland, and Italy  have obtained over the period nominal price increases in their own currencies in excess of 4  % per  annum. 3.10. On the one hand it can be argued that with the limited economic and monetary co-operation  between the Member States that has existed since 1969 the flexibility in the common price system  that results from the use of green rates has been essential to the continued functioning of the  common market organizations: if this flexibility had not been provided by the agrimonetary system,  it would have had to have been provided in some other way, as otherwise the strains on the common  market organizations would have been too great. 3.11. It can also be argued that differentiating green rates by market does not introduce new  principles in the agrimonetary system, but is rather a refinement of the basic principle of  allowing the agricultural conversion rates to deviate from market rates. 3.12. On the other hand, it is an unsatisfactory situation where Member States are able to use the  green rate system to pursue national pricing policy objectives which conflict with the Community  common price interest. For several years a central element in Community agriculture policy has been  to restrain institutional prices in order to try to contain surplus production, and thus budgetary  cost. The effect of freezing prices in ECU is undermined if Member States can obtain price  increases by means of green rate devaluations. For example, after the restricted dismantling of  cereals negative gaps in 1986 and early 1987 referred to in paragraph 3.7 France and the United  Kingdom obtained reductions in their monetary gaps of 5,5 percentage points in the 1987/88 prices  package, and a further 1,5 points (France) and 3,2 points (United Kingdom) in the 1988/89 prices  package, at a time when the entire thrust of the Commission's policy on cereals was to restrain the  growth in production. 3.13. Also, as far as different green rates for different markets are concerned, the argument in  paragraph 3.11 can be countered by considering that differentiating the rates means that the  agrimonetary system is no longer a neutral instrument of market management, with all markets  affected equally. Impact on resource allocation3.14. With different price levels in Member States, and with the  isolation of agriculture from the rest of the economy implied by the green rate system and MCA's,  normal operation of the price mechanism could be expected to produce various distortions in  resource allocation, for example: (a)in appreciating currency countries, green rates below the market rate keep farm prices above the  real common price, increasing farm income: this would normally lead to greater investment and  output in agriculture than would have been the case at market rates. The converse is true for  countries with depreciating currencies if green rates are kept below the market rate. If, as a  result, production is stimulated in higher cost parts of the Community, and depressed in lower cost  areas, regional disparities are exacerbated and the Community pays an unnecessarily high price for  its food production; (b)the system of MCA's permits unequal treatment of agricultural sectors in different Member States  because it only applies to some agricultural inputs. Devaluation causes production costs to rise as  non-agricultural import prices rise and labour costs tend to increase as part of the wage/price  spiral, while, conversely revaluation tends to lead to lower production costs: thus, if green rates  remain unchanged, returns to agriculture increase in appreciating currency countries and fall in  depreciating currency ones, again tending to encourage agricultural resources towards appreciating  currency countries with higher price levels; (c)if green rates are held constant, agricultural investment and output are favoured vis-à-vis  their industrial counterparts in Member States with an appreciating currency, and vice-versa in  Member States with a depreciating currency. 3.15. On the other hand, arguments based on the working of a free market economy are of uncertain  relevance in the context of the CAP where prices are centrally determined and the intervention  system gives all producers equal assurance of outlets irrespective of the level of prices in  national currency terms and of the supply/demand situation in the Community. The Court has reviewed  the Commission and academic literature which is available in order to try to assess the impact of  the agrimonetary system on the structure of agricultural production in the Community. Apparently  little has been done to evaluate the impact of such a fundamental element in the functioning of the  market organizations. Although the Commission has issued four reports, in 1978, 1979, 1984 and 1987  (), on the economic effects of the agrimonetary system, these comprise no more than series of  official statistics on each market, with analytical commentary. In the 1978 and 1979 reports the  Commission interpreted the statistics as showing that Member States with positive MCA's were  attracting resources into agriculture and increasing their share of final agricultural production  at the expense of Member States with negative monetary gaps. These findings, however, have been  disputed (), and the more recent reports have been less emphatic. 3.16. The explanation for this state of affairs obtained from officials in the Member States  visited was that the agrimonetary system is only one of many factors affecting developments in  Community agriculture, and it is very difficult if not impossible, to isolate the agrimonetary  impacts from all other factors. The Court recognizes this, but, nonetheless, considers that greater  efforts should have been made by the Commission to gather evidence which would either support or  reject the theoretical hypotheses regarding the economic impact on the common market  organizations. 4. THE SWITCHOVER MECHANISMRationale for switchover4.1. The switchover  mechanism was introduced in 1984 as a means of overcoming the difficulty of dismantling positive  MCA's during a period when price increases in ECU were severely restrained. Certainly, the  mechanism has prevented the creation of new positive MCA's for the fixed rate currencies, and the  preexisting positive MCA's of FR of Germany and the Netherlands have been dismantled. This  achievement, however, has been at the price of: (a)additional conceptual complexity, with the creation in the green ECU of an artificial set of  exchange values; (b)hidden increases in the common level of prices. Artificial exchange values4.2. The creation of the green ECU, by multiplying the central rates of  each currency against the ECU by the correcting factor means that a wholly notional set of exchange  values is created in addition to the preferential green rates used to convert the common ECU farm  prices into national currencies. 4.3. Under the pre-switchover system the objective of dismantling monetary gaps was synonymous with  bringing green rates into line with market rates. With the introduction of the correcting factor,  the short term objective has been shifted to dismantling the monetary gaps between the green rates  and the artificial green central rates. For example, in situation 5 of Figure 1, dismantling the  monetary gaps would mean 2,34113 DM = 7,85183 FF = 1 ECU (green) rather than 2,05853 DM = 6,90403  FF = 1 ECU, which are the EMS central rates. Thus, if at some time in the future all the gaps have  been removed, the green rates will still not be aligned with real exchange rates. A further  conversion will be needed to achieve this, involving a decision by the Council to remove the  correcting factor. To do this, all the green rates will have to be revalued by the correcting  factor. Unless, however, the Community is willing to accept a reduction in the amounts received by  beneficiaires in national currencies, i.e. to abandon the 'Gentlemen's Agreement` of 1979, it will  be necessary to increase the common prices in ECU. At this point, the increase in the common price  level caused by the switchover mechanism, and largely hidden at the present time, will become  apparent. In the following paragraphs the impact of the correcting factor on the common price level  is analysed. Impact of correcting factor on common price level4.4. The revaluation of the ECU for agricultural  purposes, i.e. the green ECU, which results from multiplying the ECU by the correcting factor means  that the level of common agricultural prices is effectively increased. The green ECU does not  affect intervention prices in national currency, which continue to be expressed in terms of  unchanged green rates against the real ECU. However, the differences in the common price level in  national currencies are measured by the positive and negative monetary gaps either side of the  common price level in ECU. If the dividing line is raised, as it is by the application of the  correcting factor, then the common price level is raised. This can be seen from Figure 1. Taking  the position at situation 3, if the positive MCA of 7,8 points and the negative MCA of 9,5 points  are dismantled, the common price level between the FF and the DM will be at 1 ECU (green) = 2,31728  DM = 7,10590 FF, which is 3,37  % higher than the central rate relationship (1 ECU = 2,24184 DM =  6,87456 FF). Thus, after a realignment involving an increase in the correcting factor and thereby a  raising of the common price level, the effects of the higher price level feed through as green  rates are progressively devalued afterwards. 4.5. As it is the DM which has remained the strongest currency, and which has been revalued the  most within the EMS, in practice the new method of calculation means that the evolution of the  green ECU central rate is tied to the evolution of the central rate of the DM against the ECU. At  each revaluation of the DM, the level of common agricultural prices has been increased. At the  beginning of 1988 the cumulative effect of these revaluations was that the level of common prices  had been raised in this way by 13,7  % since April 1984. Thus, the green ECU is 13,7  % higher than  the real ECU, and at each realignment the ECU for agricultural purposes diverges more and more from  the real ECU. 4.6. Raising the common level of prices in this way has the following consequences: (a)the correcting factor provides for automatic increases in the common price level each time there  is a realignment involving a revaluation of the DM against the real ECU; increases in the price  level are tied to the appreciation of DM, which reflects the strength of the industrial economy of  the FR of Germany rather than the requirements of Community agriculture; (b)these automatic increases in the common price level are divorced from the normal annual price  fixing procedures for the agricultural markets; (c)increasing the common price level in this way rather than by overt political agreement to raise  prices in ECU means that the increases are largely hidden: the ECU prices agreed in the annual  price fixing no longer reflect the real level of common prices. 4.7. The switchover mechanism is a technical device which has enabled positive MCA's to be  dismantled while at the same time maintaining the appearance of a restrictive common price policy.  In reality, however, it has not enabled positive MCA's to be dismantled without any increases in  common prices, indeed its operation is entirely consistent with the 1979 Gentlemen's Agreement: the  majority of the reductions in positive MCA's have been compensated for by increases in the common  price level (). As shown in paragraphs 4.2 - 4.3, this will become fully apparent when all the  monetary gaps have been removed and it becomes necessary to realign green rates with market rates,  and raise ECU prices to preserve the values in national currencies of those ECU prices. The Court  considers, therefore, that a major consequence of the switchover has been that real developments in  common agricultural prices have been obscured. 4.8. In chapter 6 of this report, the budgetary impact of the increase in the common price level  caused by the correcting factor is assessed (paragraphs 6.14 - 6.20). 5. THE CALCULATION AND APPLICATION OF MCA'SIntroduction5.1. In order to  asssess whether the MCA's themselves are neutral in their impact on the sound management of the  common market organizations, it is necessary to examine whether the manner in which MCA's are  calculated and applied correspond to the objectives of monetary compensation, as set out in  paragraph 1.4 above. In summary, the MCA's as applied should enable the market organizations, and  their intervention systems in particular, to function without distortion or discrimination and  should not impede trading flows. Basis of calculation of MCA's5.2. The principle underlying the application of MCA's is that all  trade into or out of a Member State should take place at a common price level. The level chosen is  the one at which the intervention system supports the market. The starting point for the  calculation of MCA's, therefore, is the intervention price. In the case of the beefmeat market,  market prices have been below the intervention price over a long period, so in 1984 it was decided  to use 85  % of the intervention price for calculating MCA's. Since 1987 there have been changes to  the intervention arrangements in the beefmeat, milk and cereals markets resulting in price levels  below the intervention prices being supported. Accordingly, there has been a downward adjustment of  the intervention price base used for the calculation of MCA's in these markets. 5.3. Table 1 sets out the bases of calculation used, as at the beginning of 1988. Various other  adjustments are applied in some sectors (e.g. the processing costs allowances included in skimmed  milk powder and butter intervention prices are excluded when calculating MCA's for other milk  products). 5.4. For products derived from the base products, standardized technical yield coefficients are  applied. These are in many cases the same as the coefficients used for import levy purposes, but in  the case of certain cereals (maize and products derived therefrom) special coefficients have been  developed following rulings by the Court of Justice that the import levy coefficients resulted in  overcompensation, and threatened trade distortion. 5.5. The system for the calculation of MCA's is necessarily a flat rate one. In most cases, where  the level of market prices is directly related to the price level supported by the intervention  system, basing the MCA calculation on the intervention price, adjusted to reflect the actual price  support level, works reasonably well and does not in general terms lead to market distortions.  Further, it seem that, at least at present, the technical coefficients used in respect of derived  products are not causing difficulties. This does not necessarily mean that the coefficients are  correct in every case, but operators recognize the need for a standardized system and are reluctant  to contest the coefficients applied by the Commission unless serious anomalies are perceived. 5.6. However, problems have arisen where the influence of the intervention system on market prices  is limited, and where market developments are affected by factors other than the system of market  support. One of the most problematic sectors in this regard has been the pigmeat sector. MCA's in the pigmeat sector5.7. The basis for the calculation of pigmeat MCA's has changed several  times, coming down from 92  % of the basic price in 1971 to 35  % of the basic price in 1987. In  addition, it was decided in June 1987 that there should be no further increases in pigmeat MCA's,  and to achieve this the Commission was authorized to adapt the green rates as necessary. To avoid  distortions of trade this only applies so long as the difference between the cereals and pigmeat  monetary gaps is 8  % or less. Following the price decisions for 1988/89, as a result of this  policy, pigmeat MCA's were zero in all Member States except Greece, Ireland, Italy and the United  Kingdom. 5.8. The argument that has prevailed is that pressed most vigorously by the French authorities as  they sought to reduce, indeed eliminate MCA's in this sector. This is that pigmeat should not be  treated as a base product, but as a product derived from cereals. MCA's therefore, should  compensate only for the cereals component in pigmeat production. The origins of the problems in  this sector are, however, structural. Pigmeat production in the Netherlands, Northern Germany and  Flanders is intensive, with low unit costs of production based on a high use of cheap cereal  substitutes (soya, tapioca) imported through Rotterdam and Hamburg, and which do not attract MCA's.  French pigmeat production is concentrated in the North West (Brittany), which is further from the  main French markets than are the main Dutch and Belgian production areas, and uses a higher  proportion of cereals in the pig ration. The comparative advantage of the Dutch, German and Belgian  producers was seen to be strengthened further by the agrimonetary system as both the Netherlands  and the FR of Germany had positive MCA's (granted on export) and Belgian negative MCA's were lower  than French ones. Although the evidence was not conclusive that the level of MCA's generated by  treating pigmeat as a base product was the cause of the French pigmeat industry's difficulties in  the 1980's, it was agreed to reduce MCA's by basing the calculation on a standardized cereals  component. The 35  % of the basic price currently used reflects this. 5.9. This solution, however, cannot be said to result in a neutral level of MCA's because of the  wide variation in the proportion of cereals used in pigfeedingstuffs from Member State to Member  State. It has been estimated () that in 1983 cereals accounted for 37,2  % of the cost of  production of pigmeat in Denmark, 28,3  % in France, 11,7  % in the FR of Germany, and 8,4  % in  the Netherlands. Commission data () shows that the use of cereals in the production of compound  feedingstuffs (for all animals) in 1985 was 46,8  % in France, 24,6  % in FR of Germany, and 15,2   % in the Netherlands. 5.10. The decisions of the Council of June 1987 to avoid any new pigmeat MCA's by adapting pigmeat  green rates so long as the difference between cereals and pigmeat monetary gaps is 8  % or less is  another attempt to maintain the competitive position of the pigmeat producers using a higher level  of cereals in their feed. 5.11. The example of the pigmeat sector illustrates the difficulty of applying satisfactorily the  MCA system where the market is not determined by a strong intervention system. Neither the solution  of treating pigmeat as a base product, nor that of treating it as a product derived from cereals  provides a suitable formula, given the structural developments in the industry. The de facto policy  pursued in recent years, in line with the interests of pigmeat producers with depreciating  currencies, has been the complete elimination of MCA's on pigmeat. Neutral Margins5.12. The MCA's that are calculated are reduced by a flat rate amount known as the  neutral margin. This means that the monetary gap between Member States is not fully covered.  Between two Member States, one with positive and the other with negative MCA's, the neutral margins  are cumulative. The purpose of the neutral margins is to avoid any overcompensation in the  calculation of MCA's, although their flat rate nature makes this a rather approximate way of  achieving this. The Commission in 1987 sought a more flexible approach, with wider neutral margins  in those sectors where the impact of the intervention system on the market was reduced. It saw this  as a step towards further gradual dismantling of the system. However, although the Council agreed  to wider neutral margins in certain specific sectors where it was considered artificial trade flows  would not result (e.g. olive oil), Member States were not ready to devolve the general power of  Council to decide the level of neutral margins to the Commission. 5.13. The Court has examined a number of situations to see whether the existence of neutral margins  (and thus of uncovered monetary gaps) has encouraged artificial trade flows. While there seems to  be no real evidence that the neutral margins result systematically in such flows, there are  particular cases which illustrate the extent of the problem. A recent example concerns the marked  increase in expenditure on export refunds in the Netherlands. Table 3 shows that in the cereals,  sugar and milk and milk product sectors there was a very large increase in export refunds paid by  the Dutch paying agencies during the first six months of 1988 compared with the first six months of  1987. At the same time export refunds paid by France for cereals and milk products, and by Belgium  for cereals and sugar, fell significantly. Although there has always been a tendency for exports to  be directed through strong currency Member States, the 1988 increases were exceptional. The Dutch  authorities observed a considerable increase in the export refunds paid to firms established  outside the Netherlands and without subsidiaries in the Netherlands: for the period January to  April 1988  60  % of export refunds in the sugar sector paid by Dutch intervention agencies were to  such firms, whereas in 1987 the percentage was only 7  %. 5.14. A particular traffic that has been observed involves loading goods at Antwerp in Belgium,  sailing them along the Scheldt to Vlissingen, where they are declared and cleared for export, thus  obtaining the export refunds in HFL. Another involves ships loading at Dunkirk in France and  sailing to Vlissingen for export clearance. Among the reasons for this are that: (a) both French and Belgian firms could obtain an increase of 3  %-3,5  % in export refunds in  national currency by exporting through the Netherlands. This is shown in Annex VI in respect of  cereals exports for June 1988. The advantage was slightly greater in respect of milk products, and  slightly less in respect of sugar; (b)Dutch paying agencies pay export refunds more quickly than paying agencies in other Member  States, which means that exporters face lower financing costs exporting through the Netherlands. 5.15. Traders who export to third countries through the Netherlands in this way are taking  advantage of an uncovered monetary gap made up of the following: (a)the neutral margin for the two countries in question, added together: in the case of cereals,  0,9 points of the 1,0 point neutral margin for Netherlands remaining uncovered plus 1,5 points for  France (total 2,4 points), and plus 0,5 of the 1,5 points for Belgium (total 1,4 points); (b)additional parts of the monetary gap not covered by MCA's because of rounding and application of  the non-cumulation rule (see Annex III): in the case of cereals there is no more than the 0,029  points of rounding in respect of France: for milk products, however, an additional 0,385 points  were uncovered in the Netherlands by virtue of the non-cumulation rule; (c)additional parts of the monetary gap caused by the extent of the actual divergence of market  rates of exchange as compared with the central rates: in this case 0,9 points between the  Netherlands and France, and 1,7 points between the Netherlands and Belgium: this is a consequence  of the EMS, rather than the agrimonetary system. >TABLE>5.16. The Court considers that it is unsatisfactory that the rates applied in the  agrimonetary system should in any way encourage triangular traffic of this kind. Further, the Court  has some doubts about the legality of the procedures adopted by traders to obtain export refunds in  this way, and is examining this aspect further in its audit of export refunds. It is, therefore,  important that action is taken when such situations are identified to modify the rates and remove  the opportunity. An important step towards this would be the revaluation of the Dutch green rates  for the products in question to remove the uncovered monetary gaps. Although the 1988/89 prices  package included a 1,0 point revaluation of the dairy products green rate from 25 July 1988, no  other decisions were taken which would affect the uncovered monetary gaps. 5.17. An important consequence of this is that the export refunds paid in the Netherlands cost the  Community budget more than if they were paid in France or Belgium. This is explained in chapter 6,  paragraphs 6.19 - 6.20. 5.18. The Court has also examined whether similar factors explain the very large flow of skimmed  milk powder into German intervention stores from other Member States particularly in 1986. However,  it appears that other factors () provide the main explanation of this, particularly the fact that  the cost of prefinancing products put into intervention were lower in the FR of Germany. 5.19. The Court concludes, therefore, that the absence of systematic distortion indicates that the  departure from the principles of monetary compensation that the neutral margins constitute can be  justified. However, the fact that specific cases of artificial trade flows do occur as a result  means that the Commission and Member States need to act promptly when they are identified. 5.20. The case referred to in paragraphs 5.13 - 5.17 highlights a specific problem with the neutral  margins which becomes more significant with the tendency to increase them for certain products,  namely that it becomes possible to dismantle the MCA's but still be left with a gap between the  green and market or central rates. It is necessary, therefore, to ensure that the dismantling  process deals with the real monetary gap, and not just the applied gap. Processed Products5.21. MCA's are applied on a range of processed goods containing combinations of  milk and milk products, sugar and cereals (known as the Non-Annex II products as they are not  specified in Annex II of the EEC Treaty). These products include such items as biscuits,  confectionary. The MCA's are calculated on the basis of the MCA's applicable for the base products  incorporated in the final products, less 10  %. Flat rate quantities of the base products are used  for this. 5.22. A large number of products are covered by this regulation, with varying proportions of the  value of the final product accounted for by the base products. In accordance with the principle  that MCA's should only be applied if they have an economic impact, various attempts have been made  to fix thresholds below which MCA's are not applied. Since June 1987 MCA's of a value not exceeding  3 ECU/100 kg are not applied. While this provision is an improvement on previous arrangements,  which were excessively complex and arbitrary in their effects, it can be questioned whether the  threshold is high enough. The competitive market situation facing highly processed products with  substantial value added is not affected significantly by the agrimonetary situation of the base  products incorporated in them. MCA's should only be applied where it can be shown that their  absence would lead to trade distortion. The administrative arrangements in respect of MCA's for  processed products are particularly burdensome, and should be avoided whenever possible. Absence of MCA's in certain sectors5.23. As noted in paragraph 2.7 above, MCA's are not applied in  all sectors despite the existence of green rates. According to the principles underlying the  system, this should be because there are no dangers of disruption either to the market support  arrangements or to trade. This is considered below in respect of two sectors, rice and sheepmeat. Rice5.24. In its 1978, 1980 and 1985 annual reports () the Court drew attention to the problem of  triangular trade in rice occurring as a result of the absence of MCA's in the rice sector. The  Court identified shipments of rice from third countries entering the Community in Member States  where the import levy was low because of an overvalued green rate, and then reexported immediately  to the real destination in other Member States. As a result, own resources were lost (estimated at  1,5  Mio ECU in 1984 and 2,0  Mio ECU in 1985). 5.25. Despite the clear evidence of this traffic - it was sufficiently striking to appear clearly  in the official statistics of the Community - the Commission and Member States resisted taking  action until 1986. Then the depreciation of the UKL and the opening up of a wide negative monetary  gap meant that large quantities of rice for the FR of Germany and the Netherlands flowed through  the United Kingdom. Imports of long grain husked rice from the United Kingdom increased from 77  tonnes in 1985 to 27  262 tonnes in 1986 in respect of the FR of Germany, and from 20 tonnes to 30   636 tonnes in respect of the Netherlands. The Court estimates the loss of own resources involved at  3,7  Mio ECU. When action finally was taken, interestingly, it did not take the form of the  introduction of MCA's. Instead, a special conversion rate virtually equivalent to the market rate  has been introduced for the purposes of calculating the rice levies. This means that there is no  longer a monetary gap left uncovered. Sheepmeat5.26. Sheepmeat is covered by intervention arrangements (), and in principle MCA's may be  applied. In practice, however, whatever the inconveniences caused by currency fluctuations and  particularly by the United Kingdom's shift from a positive monetary gap to a negative one, they  have not been sufficiently persuasive to bring about the application of MCA's in this sector. 5.27. Sheepmeat production is concentrated in France, Ireland and the United Kingdom, with the main  intra-Community trade flows from Ireland and the United Kingdom to France. While the United Kingdom  had a positive monetary gap the absence of MCA's reduced the competitive position of exports to  France, but the opening up of a substantial negative gap since 1986 resulted in United Kingdom  exports putting pressure on the French market. This has been dealt with by other measures,  especially the 'clawback` arrangements on exports of certain types of British sheepmeat, rather  than by the introduction of MCA's. Complexity of the MCA system5.28. The Commission has itself acknowledged () that the system has  become exceptionnaly complex, and that changes have 'increasingly robbed it of all transparency`.  The question of complexity can be considered at a number of levels, i.e. conceptual complexity,  complexity in the rules for calculating MCA's, complexity in the day-to-day application of the  system with its large number of individual rates and tariff headings, procedural and control  requirements. 5.29. Conceptually, the system as it has developed has become more complex, and the introduction of  the switchover with the correcting coefficient and the green ECU means that very few people other  than the specialists in the Commission, the Member States' administrations and in commerce  understand what the system now involves. As paragraphs 4.4 - 4.7 show, the lack of transparency in  respect of the system of the common level of prices is a major criticism in this regard. 5.30. Also, the detailed rules for calculation the MCA's and for dealing with dismantling MCA's  under the June 1987 agreement are complex, and it requires a degree of expertise and application to  master them. The importance of doing this, however, is shown by the number of organizations -  government departments, trade bodies, trading concerns - which operate their own computer models to  'shadow` the official calculations of the Commission, notably of the weekly changes in variable MCA  rates. The problem of complexity at this level should not be overemphasized: few people need to  know the fine details of how calculations are carried out, for most people affected by the system  it is sufficient to know how to apply the results. 5.31. At the level of complexity in day-to-day application, it is true that there are thousands of  rates, and for the smaller, occasional trader it is difficult to apply the system. It is not,  however, clear that the system is more complex than other EC agricultural measures, and, as the  system is ideally suited to computerization in some respects it is straightforward to apply. The  control requirements are no more severe than the usual physical and administrative controls on  agricultural trade, of which they form a part. 5.32. In overall terms, however, it must be recognized that the agrimonetary system is obscure,  complex, and difficult to understand. This is inevitable, once the decision to have monetary  compensation is taken, but it is unsatisfactory that Community arrangements for the management of  the common market organizations should involve this degree of complexity. Also, the greater the  complexity, the more likely it is that errors will be made and that attempts will be made to  manipulate the arrangements, with consequent financial loss to the Community (see for example the  case of rice imports considered in paragraphs 5.18 - 5.19). Frauds and irregularities5.33. Frauds and irregularities involving MCA's can occur both in  intra-Community and third country trade. In the case of third country trade, however, it is  normally the export refund or import levy which is the prime reason for the fraud or irregularity,  the MCA element being merely incidental. This section, therefore, is concerned with frauds and  irregularities in intra-Community trade only. 5.34. Table 4 sets out the number of cases of frauds or irregularities involving MCA's in  intra-Community trade reported by Member States under Council Regulation (EEC) N° 283/72 (). These  142 cases involve an estimated 11,5  Mio ECU. At the beginning of September 1988, 95 of these cases  were considered as closed, and 1,5  Mio ECU (13  % of the total amount involved) had been  recovered. 5.35. The table shows that 58 of the 142 cases reported concern the United Kingdom. Nearly all of  these cases concern problems on the border between Northern Ireland and Ireland. In 1980 and 1981  when the United Kingdom had high positive MCA's, pigs and cattle were smuggled across the border to  Northern Ireland to avoid the MCA payable on import, and then legally exported back to Ireland,  thus qualifying for the MCA payment. In some cases the animals repeated the journey several times.  This 'carousel` arrangement was stopped when improved controls were introduced, but also because  the smuggling became no longer worthwhile as the monetary gaps between the United Kingdom and  Ireland diminished. Subsequently, in 1986, the pound sterling depreciated substantially, leading to  a large negative gap, with significant disparities in MCA's between the two countries. Cattle  reared in Northern Ireland were smuggled across the border to avoid paying the MCA on import, were  slaughtered in Ireland and the meat then exported legally to the United Kingdom mainland where it  attracted a large MCA payment. This illegal trade was estimated () to have netted in excess of UKL  100 (150-160 ECU) per head of cattle, paid from the Community budget. In order to stop this trade,  special task forces were established in November 1986 by the United Kingdom and Ireland customs  authorities to police the border in an attempt to prevent the smuggling. Although there has been a  reduction in the cases reported, it is unlikely that this traffic has completely stopped, given the  difficult security problems on the border and the continuing existence of monetary gaps between the  two countries. The Court's investigations, however, indicate that the Irish and British authorities  are taking all reasonable steps to prevent irregular traffic. 5.36. The above problem is the most extreme example of the type of fraud that is encouraged by the  existence of large agrimonetary disparities on either side of a border across which there is a  great deal of commerce, and close economic integration. As long as such disparities exist, it is  inevitable that there will be a degree of fraud, probably only the most blatant of which will be  detected. 6. THE BUDGETARY IMPACT OF GREEN RATES AND MCA'SIntroduction6.1. For an  instrument of policy which occupies such a central place in the functioning of the common  agricultural policy it is important that the budget and accounts present a clear and comprehensive  picture of the budgetary impact of the agrimonetary system as a whole. Also, the meaning of data in  the accounts should be clear and unambiguous so that they can be interpreted readily without  misunderstanding. This is not, however, the case at present: (a)the amounts recorded in chapter 28 of the general budget, which is the only part of the budget  where the effect of MCA's is specifically identified, cover only part of the direct budgetary cost:  in particular, the impact of MCA's on import levies and export refunds is not specifically  identified in any budget lines; (b)the budgetary impact resulting from the use of the green rates when payments are made from the  budget (or agricultural revenue is received), and the use of market rates when amounts are recorded  in the budget is hidden: in addition to the lack of transparency that this involves, it makes the  interpretation of accounting data difficult. In the following sections the Court presents the results of an evaluation of the full budgetary  impact, direct and indirect, of the agrimonetary system. The budgetary cost of the switchover  mechanism is also analysed. Direct budgetary impact, MCA's6.2. Table 5 sets out a classification of the direct budgetary  impact of MCA's, identifies where the amounts concerned are recorded in the budget, and indicates  whether they can be identified separately from the accounts. This shows that the only data on the  direct budgetary costs of MCA's that are separately identified are those presented in chapter 28 of  the general budget, and that these present a partial picture only. MCA's on intracommunity trade  are shown in full, but those on trade with third countries are almost entirely hidden. >TABLE>6.3. Following the publication of the Court's opinion of July 1980 () concerning  MCA's, a change in budgetary nomenclature was made by the Commission to try to show more clearly  the full budgetary impact of MCA's, but this did not go far enough, and failed to take into account  some of the key parts of the Court's opinion. Thus, as Table 5 shows, all MCA's which affect import  levies are recorded as part of those levies in chapter 10 of the revenue budget. This covers  positive MCA's which are added to the levy, as in the case of the FR of Germany, for example, and  negative MCA's which reduce the amount of levy, as in the case of Greece, for example. The only  exception to this is where the negative MCA deducted from the import levy is greater than the levy  itself, so that a net grant of MCA is made to the importer. This item of net expenditure is  recorded in budget item 2810, and nothing is recorded under import levies. Accounting for MCA's and  import levies in this way is unsatisfactory, as it means that a substantial part of the impact of  MCA's is not known, and, further, that the data available on import levies does not show the gross  revenue from them. 6.4. Secondly, negative MCA's charged on exports from Member States with depreciated currencies,  and which reduce the export refund, are also not accounted for separately: the net export refund,  less the MCA charged, is recorded for each market sector in the appropriate chapter of the EAGGF  budget. If the MCA is greater than the refund, nothing is recorded as a refund, and the net excess  is entered in chapter 10 as an agricultural levy. This is not consistent with the practice whereby  positive MCA's added to export refunds in respect of Member States with appreciated currencies are  declared separately from the refunds, in item 2811. Thus not only is another important part of the  budgetary impact of MCA's not identified in the budget, but also the full cost of export refunds is  not shown. 6.5. The Court has tried to estimate the full direct budgetary cost of MCA's including: >TABLE>(a)those amounts recorded in the annual accounts under chapter 28; (b)MCA's deducted from export refunds; (c)MCA's added to and deducted from import levies. Amounts recorded in the annual accounts6.6. Table 6 shows the amounts recorded in the annual  accounts under chapter 28 for the period 1983 to 1987. This table shows that in 1987 gross  expenditure was 1300,9  Mio ECU, offset by 'negative expenditure` - i.e. revenue - from MCA  receipts of 664,0  Mio ECU, leaving a balance of 636,9  Mio ECU. Taking MCA's in intra-community  trade only, which is the only complete part of the budgetary cost of MCA's shown, gross expenditure  was 1073,9  Mio ECU, offset by revenue of 664,0  Mio ECU, leaving a balance of 409,9  Mio ECU net  expenditure. 6.7. The table shows that individual budget items and the net totals fluctuate considerably from  year to year, depending on the size of the monetary gaps. For example, the fall in net expenditure  in 1984 and 1985 reflects the degree of success in dismantling MCA's after the introduction of the  switchover, but in 1986 and 1987 there was a period of relative monetary instability resulting in  wider negative monetary gaps, which is reflected in the amounts recorded in the accounts. MCA's deducted from export refunds>TABLE>6.8. As far as the budgetary impact of MCA's  deducted from export refunds is concerned, no data is available at Commission level on the actual  amounts involved, because the current accounting instruction from the Commission requires Member  States to declare refunds net of MCA's. During its mission to the United Kingdom and France the  Court established that the intervention agencies have gross data, i.e. the full export refund  separate from the MCA amount, more or less readily available in their internal accounting systems,  and that it would be possible without any great administrative difficulty to declare the gross  data. For the Court's examination, however, it was not feasible to assemble all the gross data from  each Member State, so an alternative estimate has been made, based on the Commission's budgetary  preparation work. For each market in which MCA's are applied, the Commission estimates an amount by  which the forecasts of export refunds should be reduced. This is done using historical data on  actual trade flows, combined with the latest agrimonetary and monetary parameters. In the last  estimate for the 1987 budget, prepared by the Commission's services at the end of August 1987 (),  the estimated amount by which export refunds should be reduced was 216  Mio ECU. For the 1988  budget, the estimated amount was 111  Mio ECU (). MCA's added to and deducted from import levies6.9. Again, no data are available in the Commission  on the actual amounts of MCA's added to and deducted from import levies by the Member States. The  Commission makes an estimate as part of its preliminary draft budget, based on import forecasts,  forecasts of average levy rates, and MCA rates that accord with the Commission's proposals for  dismantling MCA's. For the 1987 budget the net effect of MCA's added to and subtracted from import  levies was forecast at a 36  Mio ECU reduction in levies (), for 1988 it was a 57,5  Mio ECU  reduction (). Indirect budgetary impact of the agrimonetary system6.10. In addition to the direct budgetary  impact of MCA's, there is a cost to the budget resulting from the use of green rates, which give  different values to the common prices fixed in ECU when they are converted to national currencies.  This is the budgetary impact of having different common price levels in different Member States. Dual rate coefficient6.11. This budgetary impact results from the procedure whereby, when an  institutional common price amount denoted in ECU is paid from the budget to a beneficiary it is  converted into national currency using the green rate, but when it is recorded in the accounts it  is reconverted into ECU using a market rate of exchange (). Thus, for example, in May 1988, in  applying the prevailing green rates to 100 ECU of aid for skimmed milk powder for incorporation  into animal feed, a beneficiary in FR of Germany received DMs to the equivalent of 115,15 ECU when  recorded in the accounts, one in France received FFs to the equivalent of 106,26 ECU, and one in  the United Kingdom received UKL to the equivalent of 99,22 ECU. This is shown in Annex V. Thus, in  this example, the cost to the budget of the aid paid in FR of Germany is 16  % higher than that  paid in the United Kingdom. By the same token, an item of agricultural revenue, such as sugar  levies, received in the FR of Germany is worth 16  % more to the budget than the same item in the  United Kingdom. 6.12. The budgetary impact of having different price levels in each Member State can be represented  by the 'dual rate coefficient`, which is defined as follows: Dual rate coefficient  =  1 ECU, converted into national currency, at the green rate 1 ECU,  converted into national currency, at a specified market rateA dual rate coefficient exists,  therefore, for each Member State and for each market where there is a separate green rate. 6.13. Under the agrimonetary system which existed prior to 1984 and the introduction of the  switchover, those Member States with positive MCA's and a price level in national currency above  the common price level had a dual rate coefficient greater than one: i.e., the effect of the  coefficient was to increase budgetary expenditure. On the other hand, those Member States with  negative MCA's and a price level in national currency below the common price level had a dual rate  coefficient less than one, so that its effect was to reduce the level of budgetary expenditure in  ECU. In terms of budgetary impact, therefore, the increased cost to the budget of the higher price  level in the strong currency Member States was offset by the reduced cost of the weaker currency  Member States. The larger the gaps between the green and central, or market rates, the greater the  impact on the budget of the dual rates. Impact of the switchover on the dual rate coefficient6.14. The introduction of the switchover,  however, by enabling the Community to reconcile the FR of Germany's interest in preserving the  level of domestic prices with the Community's interest in avoiding the creating of new positive  MCA's, has had a significant effect on the relationship between green and market rates, and thus on  the dual rate coefficients. For FR of Germany and the Netherlands, which had coefficients greater  than 1 before the introduction of the switchover, at each realignment where the DM and the HFL have  been revalued, the double rate coefficients have increased. They have only been reduced when the  positive gaps that were in existence in April 1984 have been dismantled by revaluation of their  green rates. For the Member States with negative gaps, the dual rate coefficients have increased as  those gaps, both 'natural` and 'artificial` have been dismantled (). The green rates for these  Member States are devalued towards the green central rate (the central rate adjusted for the  correcting factor) which means that once the green rate has been devalued past the central rate the  dual rate coefficients for these Member States can also exceed unity. As situation 5 of Figure 1 shows, a result of the switchover mechanism, therefore, is that at each  realignment and subsequent green rate devaluations, the green rates for both Member States with  negative and positive monetary gaps diverge further and further from real exchange rates,  increasing the dual rate coefficient. 6.15. Table 7 shows the dual rate coefficients for cereals and milk and milk products for all  Member States as at May 1988. This shows that only those for the United Kingdom and Greece are less  than one. 6.16. The increased impact of the dual rate under the switchover mechanism, therefore, reflects the  impact on budgetary expenditure of the effective increase in the common price level caused by the  correcting factor. Under the pre-April 1984 arrangements an increase in common prices in ECU agreed  by the Council resulted directly in higher budgetary expenditure without influencing the dual rate.  Under the current arrangements with switchover, the increase in common prices caused by an increase  in the correcting factor at the time of a realignment leaves ECU prices unaffected, but increases  expenditure via the dual rate effect, immediately for FR of Germany and the Netherlands, and as  green rates are devalued for the Member States with negative gaps. Thus, a devaluation of a green  rate without any change in market rates has the following effects: (a)it increases the level of common prices in national currency for the beneficiaries in the Member  State concerned; (b)it reduces the negative monetary gap, resulting in a positive budgetary impact in respect of  exports and a negative one in respect of imports; >TABLE>(c)it increases the dual rate coefficient, which means a direct increase in  budgetary expenditure. This last point is an important consideration in relation to requests from Member States for  devaluations of their green rates and the need to dismantle the negative monetary gaps in order to  achieve the same common price level throughout the Community. The Commission has estimated in the  context of the 1988/89 price fixing that a dismantling of 1 percentage point of the monetary gaps  for the Member States with negative MCA's would have a net impact on the budget of 220  Mio ECU  additional expenditure. The dual rate effect itself would increase expenditure by 210  Mio ECU.  With the current budgetary discipline limiting agricultural expenditure, this is an additional  constraint. Budgetary impact, 19876.17. The dual rate coefficients affect every line in the EAGGF expenditure  budget, and chapter 10, agricultural levies, in the revenue budget. However, this effect is not  separately identified. In its annual report on the 1978 financial year () the Court criticized the  fact that the published budget and the accounts do not permit the effect of dual rates to be  assessed. In its reply, the Commission argued that the dual rate effect was weakening as monetary  gaps were reduced. This may have been so under the pre-April 1984 system, but under the switchover  arrangements the effect is becoming more significant and should be clearly identifiable. 6.18. The Court has calculated the effect on the 1987 EAGGF expenditure accounts (). For the 10  months expenditure given in the official accounts, it amounts to 1137,5  Mio ECU. If expenditure  for the full 12 months of 1987 is taken, the impact of the dual rate increases to 1365,1  Mio ECU.  In both cases these amounts are 5,0  % of total expenditure. For agricultural levies in chapter 10 of the revenue budget there is insufficient disaggregated  data at the level of each market to permit a detailed calculation of the impact. Once again, it is  necessary to fall back on budget forecast data. For 1987, the Commission forecast the double rate  effect at 50  Mio ECU increase in budget revenue, for 1988 the forecast is 100  Mio ECU. For the sugar levies in Chapter 11 of the revenue budget, the double rate coefficient effect  calculated from the accounts is 108,5  Mio ECU for the full 12 months of 1987. Budgetary impact of artificial trade flows6.19. Paragraphs 5.13 - 5.17 describe how the existence  of uncovered monetary gaps caused partly by the structure of the agrimonetary system has encouraged  the export to third countries of sugar, cereals and dairy products from other Member States, for  example France and Belgium, through the Netherlands, in order to obtain the export refund paid in  HFL. This situation leads directly to increased Community budget expenditure, because of the higher  price level in the Netherlands compared to Belgium or France reflected in the dual rate  coefficient. The data given in Annex VI (Section 3, Budgetary Impact) show that in respect of the export of  cereals from France in June 1988, an export refund less the MCA payable on export, of 100 ECU at  the common price level, would have been charged to the accounts at 101,47 ECU if the export had  been direct from France. If, however, the cereals had first been exported to the Netherlands and  then exported to third countries, so that the export refund was paid in HFL, the amount charged to  the accounts would have been 106,06 ECU, which is 4,5  % higher. The corresponding figures for  cereals exported from Belgium would have been 110,64 ECU if exported directly, and 114,27 ECU if  exported via the Netherlands, a difference of 3,2  %. 6.20. To assess the budgetary impact of this over a period, for cereals, sugar and milk products  requires assumptions about what would be normal levels of exports from the countries involved. From  Table 3, it can be hypothesized that at least the additional monthly expenditure during the first  six months of 1988 on export refunds in the Netherlands for cereals (+ 65  Mio HFL), sugar (+ 80   Mio HFL), and milk products (+ 100  Mio HFL) was all above 'normal`. If it is assumed that normally  this expenditure should have been paid in Member States such as France or Belgium, then the Court  has estimated that EAGGF expenditure for the first six months of 1988 was increased by at least 25   Mio ECU by the refunds being paid in HFL. Estimated total budgetary impact of the agrimonetary system, 19876.21. Table 8 summarizes the  total estimated direct and indirect budgetary impact on the revenue and expenditure account of the  agrimonetary system in 1987 at 1  578,2  Mio ECU for 10 months, and 1  824,6  Mio ECU for the full  year. This is equivalent to 7  % of total expenditure, in each case. Although this estimate  contains a mixture of amounts actually declared as expenditure, budget estimates, and calculations  made on amounts declared, it gives the order of magnitude of the full impact which should be shown  clearly in the budget and in the accounts. By far the largest single amount is the impact of the  double rate coefficient. 6.22. The Court considers that, so long as the agrimonetary system continues the Commission should  ensure that the accounts show clearly the impact of the régime, in particular: (a)in third country trade, MCA's and export refunds should be shown separately, in gross terms; (b)similarly MCA's and import levies should be shown separately, in gross terms; (c)the actual impact of the double rate coefficient should be shown clearly by way of a note to the  revenue and expenditure accounts. Clarity of accounting information6.23. By not separately identifying the dual rate effect,  comparative analysis of budgetary expenditure between Member States is misleading. Paragraph 6.11  above shows how in May 1988 an item of expenditure in FR of Germany cost 16  % more to the budget  than the same transaction in the United Kingdom. It is not possible, therefore, to compare  expenditure on a budget line between Member States and identify relative activity levels, for  example. This seriously limits the value of the accounts as a source of information. Budgetary impact of the switchover mechanism6.24. A key issue in the consideration of the  budgetary impact of the agrimonetary system is the effect on budgetary expenditure of the  switchover mechanism. An evaluation of this is complex, and depends on the assumptions made. The  comparison to be made is with what would have happened if the switchover had not been introduced,  and the pre-April 1984 system had remained in operation. The elements to be taken into account are  the following for each system: >TABLE>(a)the system with switchover: (i)the direct costs of the MCA's actually applied; (ii)the costs of the dual rate effect, incorporating the increase in budgetary expenditure  resulting from the impact on this effect of the correcting factor; (iii)the impact on the level of export refunds and import levies resulting from the increase in the  gap between the level of world prices and the level of Community prices caused by the correcting  factor; (b)the pre-April 1984 'system`: (i)the costs of the increase in ECU common prices that would have been agreed by Council in the  absence of the effect of the correcting factor on the common price level in national currencies; (ii)the MCA's and green rates that would have been applied if the existing positive MCA's had been  reduced and no new ones created by means of revaluations of the green DM rates, resulting in  reductions in institutional prices in DM; (iii)the costs of the double rate effect, taking into account the green rates that would have been  applied (see (ii) above). 6.25. The central assumption that determines the outcome of the assessment is that concerning the  increases in ECU prices that would have been agreed by Council. It can be argued that, under the  terms of the Gentlemen's Agreement, increases in ECU prices would have been necessary to the extent  that prices in DM remained unchanged. This would imply increases of over 3  % at the beginning of  1984/85, over 5  % at the beginning of 1985 (), over 8  % in 1986/87 and over 1  % in 1987/88. If  this assumption is made, detailed calculations show that the budgetary impact of the two systems is  approximately equal. 6.26. The alternative hypothesis is that ECU price increases would have been smaller because of the  pressures for a restrictive prices policy. This would imply prices in DM lower than they currently  are, perhaps compensated for partly by means of income aids. In these circumstances it is likely  that EAGGF expenditure would have increased at a lower rate. Under this hypothesis, the automatic  price-increasing effect of the correcting factor has increased budgetary expenditure. 7. PRINCIPAL CONCLUSIONS AND RECOMMENDATIONS7.1. This report highlights  serious shortcomings in the current agrimonetary arrangements. These are summarised in the  following paragraphs, together with the Court's recommendations. The switchover mechanism7.2. The switchover, or green ECU, system has undermined the Community's  efforts to impose stricter budgetary discipline on agricultural expenditure by the largely hidden  way in which it has raised the effective level of prices by 13,7  % since 1984. As a result, the  level of common prices is no longer effectively fixed by the Council during the annual agricultural  price fixing. Instead, the common price level is now tied to the appreciation of the DM, reflecting  the strength of the industrial economy of the FR of Germany rather than the requirements of  Community agriculture. Dismantling monetary gaps in this context aligns agricultural prices in all  Member States on the level determined in the FR of Germany (Chapter 4). 7.3. The Court considers that the Commission should present, at the earliest opportunity proposals  for the abolition of the switchover mechanism and the green ECU. Ending the switchover should not  await full dismantling of the monetary gaps: in the interests of clarity the effective increase in  the common price level that has built up since 1984 by the workings of the switchover should be  made apparent without delay. Budgetary impact7.4. It is not possible to identify from the budget or accounts in their current  form what is the true budgetary impact of the agrimonetary system. The absence of clarity in this  regard effectively prevents meaningful interpretation of accounting data. Not only is the direct  impact of MCA's not identified fully in the budget, but also the impact of the effective increase  in agricultural prices resulting from the application of the switchover mechanism is not shown  (Chapter 6). 7.5. The Court recommends that the accounts should show clearly the impact of the agrimonetary  system, while it continues to be applied, in particular: (a)in third country trade, MCA's and export refunds should be shown separately, in gross terms; (b)similarly, MCA's and import levies should be shown separately in gross terms; (c)the actual impact of the double rate coefficient should be shown clearly in a note to the  revenue and expenditure accounts, so that comparative analysis of accounting information can be  carried out without being confused by the different exchange rates used when payments are made and  when they are charged to the budget. National pricing policies7.6. By retaining considerable influence over the level of their green  rates, and thus keeping an important degree of national control over the internal level of their  prices, Member States have been able to pursue national pricing policy objectives which have not  always been consistent with Community objectives (paragraph 3.12). 7.7. The existence of different green rates for different markets, means that the agrimonetary  system is not a neutral instrument of market management which affects all markets equally  (paragraph 3.13). 7.8. The Court considers that the process of dismantling the monetary gaps as part of the process  of abolishing the agrimonetary system should be carried out in accordance with Community priorities  for the return to a genuine common price system. Further, it considers that the objectives for  dismantlement should, whenever possible, include the ending of multiple green rates at the earliest  opportunity. Calculation and application of MCA's7.9. At the detailed level of the calculation and application  of MCA's there are a number of areas where it has proved difficult to maintain the agrimonetary  system as a neutral tool of market management. Pigmeat7.10. This sector is an example of one where market developments are affected by factors  other than the system of market support. In such cases the application of MCA's has proved  problematical (paragraphs 5.7 - 5.11). Uncovered Monetary Gaps and Triangular Trade7.11. There have been various instances where  uncovered monetary gaps, for example because of the absence of MCA's (rice sector) or because of  the existence of the neutral margins, have contributed to encouraging triangular trade. A recent  example of this is the marked increase in 1988 of exports to third countries being channelled from  other Member States through the Netherlands, at extra budgetary cost (paragraphs 5.12  P5.17 and  6.19 - 6.20) (see also paragraphs 5.24 - 5.25 for budgetary loss in respect of rice levies). 7.12. The Court recommends that the Commission and Council should act promptly to stop such  anomalies when they are identified. In the case of rice, despite repeated evidence from the Court  in its 1978, 1980 and 1985 annual reports that the Community was suffering loss of own resources,  it was only in 1986 that action finally was taken. Complexity7.13. The agrimonetary arrangements, particularly since the introduction of the  switchover and the automatic dismantling arrangements, are extremely complex and difficult to  understand. Apart from this being intrinsically undesirable, it also facilitates attempts at  manipulation, with financial loss to the Community (paragraphs 5.28 - 5.32). Prospects for complete abolition of the agrimonetary system7.14. The current objective of the  Council and the Commission is to abolish the agrimonetary system by 1992 so that a true common  price system can function as originally intended. The decisions of June 1987 and 1988, on  dismantling monetary gaps form a key, if as yet incomplete, element in this. The Court supports  this objective, but recognizes that there are considerable difficulties to be overcome. 7.15. For 20 years the common agricultural market organizations have been disturbed by the  agrimonetary system. Yet the system itself is a consequence of the inherent incompatibility between  a policy of agricultural support based on common institutional prices exerting considerable  influence over market prices, and divergent trends in member States' economies. 7.16. The implications of the decision to dismantle the agrimonetary system in the context of the  single market objectives are significant. It is clear that the existence of green rates that  diverge from market rates, and MCA's, are incompatible with a genuine single market. At a practical  level, for example, a system of MCA's cannot work without border controls to check the reality of  movement of goods for which the MCA's are charged or paid. Yet abolition of MCA's would require  Member States to accept the immediate consequences for agricultural prices of changes to currency  values following a monetary realignment. Prices that farmers receive/consumers pay would increase  in national currencies in those Member States whose currency depreciates in value, which would tend  to lead to an increase in agricultural production. They would decrease in those Member States whose  currency appreciates in value, with an inverse influence on agricultural production. If on balance  following a realignment agricultural production is increased, this may lead to an increase in  budgetary expenditure, which in turn might put at risk budgetary discipline targets. 7.17. Three factors will determine whether such arrangements will be acceptable to Member States: (a)progress towards economic and monetary convergence would reduce the frequency and intensity of  currency movements: if movements are few and relatively small, Member States may be able to absorb  their impact more easily; (b)agreement on a genuine common price level for Community agriculture that reconciles the  requirements of efficient agricultural markets and of producer incomes; (c)a reduction in the role of agricultural support prices in determining agricultural market  prices. If this link is weakened, as it has been to some extent in several markets under the  pressure of budgetary discipline (e.g. beef, milk products, cereals), then the adjustment of  agricultural prices in the market following a currency realignment will be more gradual. 7.18. If these elements are not achieved, the objective of complete and lasting abolition of the  agrimonetary system will be difficult to achieve, and the necessity for green rates that diverge  from market rates will continue, together with the requirement for some form of compensation. >TABLE>Figure 1: The Agrimonetary System >START OF GRAPHIC>Situation 1 Point of  Departure Situation 2 Realignment: Reevaluation of DM Devaluation of FF Introduction of green rates  Situation 3 Introduction of switchover Correcting factor: 1,033651 Situation 4 Dismantlement  Marketing year 1984/85 Situation 5 At 1.  1.  88 Correcting factor: 1,137282 Green rate 2,38516 DM  MCA  +1,9  %  1 ECU (g) =  2,34113 DM 7,85183 FF  ||MCA  P5,0  %   ||  ||1,137782 Green rate            7,45826 FFGreen rateGreen rate2,51457 DM2,51457 DMMCA +  10,8  %MCA +  7,8  % Green  rate1 ECU (g)  =  2,31728 DM 2,38516 DMECU (g)  =  7,10190 FF MCA + 2,8  %    1,033651|  |||||| |1 ECU = 2,51457 DM1 ECU = 2,24184 DM MCA  P3,5  % ECU = 2,05853 DM||||||ECU = 6,49211  FFECU = 6,87456 FF Green rate ECU = 6,90403 FFMCA  P9,5  %MCA  P5,9  % 6,86866 FFGreen rateGreen  rate6,49211 FF6,49211 FF| ||| || | |Cen- tral rate ECU Central rate switch- over >END OF  GRAPHIC>c19C 128Figure 2: Index of changes in intervention prices in ECU and in national  currency for the marketing years 1982/83-1988/89 All agricultural products, EUR 10>START OF  GRAPHIC>Source: Table 2(1982/83 = 100)100 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88  1988/89120  - 115  - 110  - 105  -Common prices in national currency (nominal values)Common  prices in ECU>END OF GRAPHIC>The present report was adopted by the Court of  Auditors at Luxembourg at its meeting of 30 March 1989. For the Court of Auditors Marcel MART President() Articles 39 and 40 of the  Treaty establishing the European Economic Community set out the objectives for the common  agricultural policy and the basic rules for achieving them. They provide for the common  organization of agricultural markets, excluding any discrimination between consumers or producers  in the Community. Accordingly, the functioning of the common agricultural policy's common market  organizations is based on: (a)common systems of agricultural market support, with a common price  level denominated in ECU applying throughout the Community; and (b)freedom of trade between Member  States.  () Council Regulation N° 129 of 23 October 1962, OJ N°  2553, 30.  10.  1962/62. Council Regulation  N° 653/68 of 30 May 1968, OJ N° L 123, 31.  5.  1968.  () Recitals, Council Regulation (EEC) N° 1677/85 of 11 June 1985, OJ N° L 164, 24.  6.  1985.  () See, for example, the audit of export refunds, points 4.20 - 4.59 of the Court of Auditors  Annual Report concerning the financial year 1987, OJ N° C 316, 12.  12.  1988.  () Doc. COM(87) 64 final of 27 September 1987, p. 3.  () 13th recital, Council Regulation (EEC) N° 1677/85 of 11 June 1985, OJ N° L 164, 24.  6.  1985.  () Council Regulation (EEC) N° 1889/87 of 2 July 1987, OJ N°  L 182, 3.  7.  1987.  () This is to try to ensure that institutional prices in national currency remain stable during  specified periods, e.g. a market campaign year. However, changes at other times do occur. Since the  1987/88 price decision concerning automatic dismantling of MCA's after a realignment, and the  specific provisions for pigmeat MCA's (see paragraph 5.10), provision for changing green rates at  times other than the annual price fixing has been institutionalised.  () Doc. COM(78) 20 final of 10 February 1978, doc. COM(79) 11 final of 14 March 1979, doc. COM(84)  95 final of 26 April 1984, and doc. COM(87) 168 final of 14 August 1987.  () See, for example 'The Economic Effects of Monetary Compensatory Amounts` by R. Strauss, Journal  of Common Market Studies, Vol. XXI N° 3, March 1983.  () Some of the reductions in positive MCA's have been compensated for by other forms of  compensatory aid, to avoid adverse effects on agricultural incomes.  () Quoted in 'Distorsions de Concurrence dues à la PAC`, J.  Courgeon et L.P. Mahé, Economie Rurale  N° 173, 1986.  () Table 4.13.7.5, The Agricultural Situation in the Community, Report 1987.  () These include monetary (rather than agrimonetary) factors. In addition, Dutch operators could  sell fresh SMP into intervention in FR of Germany, and buy a return load of old intervention SMP  being disposed of at a very low price for compounding into pig feed under Commission Regulations  (EEC) N° 368/77 and 443/77.  () Point 2.36, Annual Report concerning the financial year 1978, OJ N° C 326, 31.  12.  1979;  points 3.18 - 322, Annual Report concerning the financial year 1980, OJ N° C 344, 31.  12.  1981;  point 3.35 - 3.39, Annual Report concerning the financial year 1985, OJ N° C 321, 15.  12.  1986.  () Article 7 of Council Regulation (EEC) N° 1837/80 of 27 June 1980, OJ N° L 183, 16.  7.  1980.  () Page 25 'Report on the Agrimonetary System`, doc. COM(87)  64 final of 27 February 1987, p. 25.  () OJ N° L 36, 10.  2.  1972.  () P. 12 'External Trade Measures for Agricultural Produce`. Report by the Comptroller and Auditor  General, UK National Audit Offfice, 22 January 1988.  () Opinion of the Court of Auditors on a proposal for a Council regulation concerning MCA's, OJ N°  C 165, 5.  7.  1980.  () Commission internal working document of 31 August 1987.  () Commission working document VI/302/87 of 22 December 1987.  () Page B/420, volume 7/2, preliminary draft general budget, 1987, doc. COM(86)  200 of 13 June  1986.  () Page 366, volume 0/3, preliminary draft general budget 1988, doc. COM(87)  150 of 15 June 1987.  () Neither the central nor the green central rate are involved in the calculation.  () The dual rate coefficients have been reduced in the short term when a currency has been devalued  more quickly than the green rates for the Member State concerned (e.g. United Kingdom 1986, Greece  1985 and 1986).  () Point 2.31, Annual Report concerning the financial year 1978, OJ N° C 326, 31.  12.  1979.  () The expenditure charged to the official accounts presented by the Commission for 1987 were for  the 10 months January to October 1987. For more detailed consideration of this, see points 1.2 -  1.3 of the Court of Auditors' Annual Report concerning the financial year 1987, OJ N° C 316, 12.   12.  1988.  () This relates to the dismantling of 5,0 points of FR of Germany's MCA's from 1 Januari 1985, as  part of the 1984/85 price fixing decisions. This was compensated for by a concession to farmers on  the VAT rate they paid. As this was partly financed by EAGGF, adjustment for this has to be made in  the calculation. ANNEX IREGULATORY FRAMEWORK, AGRIMONETARY SYSTEM >TABLE> ANNEX IITHE ECU, THE EUROPEAN MONETARY SYSTEM AND THE COMMON AGRICULTURAL POLICY1.  The European Monetary System (EMS), which was introduced in March 1979, is the exchange rate  stabilizing system of the European Community. The basis of the EMS is the ECU, which is a 'basket`  unit whose value is equal to the sum of defined amounts of each Member State's currency, including  the drachma and sterling (but not yet the peseta and escudo). 2. Monetary stability within the EMS is achieved using the Exchange Rate Mechanism, participation  in which is not compulsory. Each participating Member State has a central rate against the ECU,  which is a target rate for the national currency, fixed by the Finance Ministers acting in concert  at a realignment conference. Under the Exchange Rate Mechanism, the participating Member States  undertake to maintain market rates for their currencies within an agreed range on either side of  their bilateral central rates. Belgium, Denmark, FR of Germany, France, Ireland, Luxembourg and the  Netherlands observe narrow fluctuations of ± 2,25% from their bilateral central rates, while Italy  observes a ± 6% margin. Greece and the United Kingdom, although including their currencies in the  ECU basket, do not participate in the Exchange Rate Mechanism. The ECU and the common agricultural policy (CAP)3. Since April 1979 () the ECU has been used as  the common unit in which amounts within the CAP are expressed (i.e. intervention prices,  agricultural levies, export refunds, production and consumption aids, etc.). Payments to and  receipts from operators in the Member States are converted from their ECU amounts into national  currencies using the representative rates known as 'green` rates. These green rates are fixed by  Council, normally as part of the annual price fixing for a full campaign year.() The  first common unit of account used in agriculture for fixing support prices was the European  Payments Union unit of account (u.a.), adopted for agricultural purposes in 1962.  ANNEX IIIMONETARY GAPS AND MONETARY COMPENSATORY AMOUNTS (MCAS)1. Under the classical  system, which operated until 1984, when green rates diverge from central or market rates, gaps are  created between the level of common prices fixed in ECU (converted notionally into national  currencies at the central or market rates) and the level of institutional prices actually applied  in the Member States using the green rates (see Figure 1). A real monetary gap is identified for  each Member State, and, if differentiated, for each market. The real monetary gap is the percentage  difference between the green rate and the market rate. There are two ways of calculating the real  monetary gaps for the Member States' currencies, depending on their situation within the EMS. For  those Member States observing the narrow fluctuation band within the EMS, the ECU central rate is  used as a proxy for the market rate, to which the Exchange Rate Mechanism ensures that it  approximates. These real monetary gaps are fixed, because they alter only if the green or central  rates are changed, which happens relatively infrequently. 2. For Greece, Spain, Italy, Portugal and the United Kingdom, the real monetary gaps calculated are  variable. They are based in principle on real monetary gaps calculated from the percentage  difference between their green rates and their market rates against the ECU over a five- day  reference period. For practical reasons, however, a proxy is devised which involves using the rates  against the narrow-band currencies within the Exchange Rate Mechanism. The mathematical calculation  of this, which is carried out each week, is straightforward, if involved. 3. The purpose of MCAs is that they should broadly fill the monetary gap. In practice there are a  number of rules in the system which reduce the MCA so that it does not completely do this. In  particular, since 1973 a flat-rate deduction, known as the 'neutral margin`, has been made.  Currently, the neutral margin is 1,5 percentage points for most products and all Member States  except for the Netherlands, where it is 1,0 points. For wine and eggs and poultrymeat the neutral  margin is 5,0 points and for olive oil, where MCAs have only been applied since September 1987 the  neutral margin is 10,0 points. The real monetary gap minus the neutral margin is called the  'Applied Monetary Gap`. The other rules affecting the size of the MCAs are: (a)non-cumulation rule [Article 5 (3) of Council Regulation (EEC) N° 1677/85]This is designed to  avoid the application of very small MCAs. It states that if the RMG less the neutral margin is 0,50  or less, an MCA percentage of zero is applied. If the RMG less the neutral margin is 1,0 or less  but more than 0,50, an MCA percentage of 1,0 is applied. As soon as the RMG less neutral margin  becomes 1,1 or more, it is applied directly as the MCA percentage; (b)'de minimis` rule [Article 9 (2) of Council Regulation (EEC) N° 1677/85]For countries with  variable MCAs, this rule stipulates that the applied monetary gap is changed only if the difference  between the new gap and the present gap is not less than 1,0 point. There are three exceptions: (i)the non-cumulation rule takes precedence over the 'de minimis` rule; (ii)if the RMG is smaller than, or equal to, the neutral margin, then no MCA will be applied  irrespective of the 'de minimis` rule; (iii)if the change in the MCA results from the introduction of a new green rate or a new central  rate, the MCAs may be 'actualized`, i.e. based directly on the new RMG; (c)the lower limit rule [Article 8 of Council Regulation (EEC) N° 1677/85]No MCA shall be applied  if it is negligable in relation to the average value of the product. Thus, on processed foods (Non  Annex II of the Treaty) and jams, MCAs are not applied if worth less than 3 ECU/100 kg. ANNEX IVTHE SWITCHOVER MECHANISM AND THE AUTOMATIC DISMANTLING OF ARTIFICIAL AND  NATURAL MONETARY GAPSRationale for 'switchover`1. The switchover mechanism was introduced in  1984 as a means of overcoming the difficulty of dismantling positive MCAs during a period when  price increases in ECU were severely restrained. It was seen, therefore, as a step forward towards  the restoration of market unity. Council Regulation (EEC) No. 1677/85 of 11 June 1985 () provided  that the switchover arrangements should be tried on a provisional basis until the beginning of the  1987/88 milk marketing year: if by this time the Council had not decided either to extend the  system in force or to introduce a new one, then the pre-existing arrangements would come back into  effect. In the event, it was decided to extend the mechanism. 2. How this device works is shown in Figure 1 to the report. As the diagram shows, the effect of  the 'correcting factor` is to 'switch` some positive MCAs below the line, converting them into  negative MCAs. If green rates are unchanged, the total monetary gap between the green rates of any  two Member States is unchanged; it is the dividing line between positive and negative MCAs that  changes. Since 1984, at each realignment of Member State's currencies, in order to avoid the  creation of new positive MCAs, the correcting factor has been increased, revaluing the green ECU  upwards in line with the strongest currency - in practice this has been the DM. Between April 1984  and the beginning of 1988 the difference between the real ECU and the green ECU, as measured by the  correcting factor increased from 1,033651 to 1,137282: that is, the green ECU was 13,7  % higher  than the real ECU at the beginning of 1988. 3. Under the 'switchover` system, therefore, the monetary gap is calculated as the percentage  difference between the green rate and the green ECU central rate. The operation of the 'switchover`  has led to further development of the agrimonetary jargon: the part of a Member State's negative  MCA which results from the operation of the switchover is called an 'artificial` negative MCA, that  part which results from changes in the exchange rate of the Member State's currency is described as  a 'natural` MCA. Automatic dismantling of natural and artificial monetary gaps4. the detailed rules agreed by  Council in June 1987 () provide for dismantling as follows: (a)up to 30  % of the new natural real monetary gap immediately after the realignment; (b)50  % of the balance of the new 'natural` real monetary gap, plus 25  % of the new 'artificial`  real monetary gap, at the beginning of the marketing year following the realignment; (c)the balance of the new 'natural` real monetary gap, plus 37,5  % of the new 'artificial` real  monetary gap, at the beginning of the second marketing year following the realignment; (d)the balance (i.e. 37,5  %) of the new 'artificial` real monetary gap at the beginning of the  third marketing year following the realignment. The first dismantling of the artifical MCAs (by 25  % at the beginning of the first marketing year  following the realignment) must be accompanied by a reduction in agricultural prices in ECU, to  offset partially the increase in prices in national currencies following the adjustments to the  green rates. This reduction in ECU prices can be compensated for, however, by national social aids  not linked to production, if the ECU price reduction leads to a reduction of prices in national  currency.() Eleventh recital, OJ N° L  164, 24.  6.  1985.  () Council Regulation (EEC) N° 1889/87 of 2 July 1987, OJ N° L 182, 3.  7.  1987.  ANNEX V COST TO THE BUDGET OF EXPENDITURE IN DIFFERENT MEMBER STATES: MAY 1988Assume  100 ECU of aid for skimmed milk powder for incorporation into animal feed, to be paid in FR of  Germany, France, and the United Kingdom. (1) FR of Germany >TABLE>(2) France >TABLE>(3) United Kingdom >TABLE  POSITION> ANNEX VIEXPORT OF CEREALS, TO THIRD COUNTRIES, JUNE 19881. Basic data >TABLE  POSITION>2.Advantage to traders in France and Belgium exporting via the NetherlandsAssume 1,333  tonnes of common wheat exported, refund = 100 ECU2.1. Export of cereals by French trader >TABLE  POSITION>2.2.Export of cereals by Belgian trader >TABLE>3.Budgetary impact >TABLE  POSITION>3.1.Export by French traders >TABLE>3.2.Export by Belgium traders >TABLE  POSITION> ANNEX VIIGLOSSARY OF TERMSThe terms in this glossary are arranged in alphabetical  order. The number preceding each term indicates the first paragraph in the report in which the item  is used.  >TABLE> COMMISSION REPLYGeneral commentThe Commission has always taken the view that the  application of MCAs is a barrier to trade in agricultural products and must be abolished as quickly  as possible. With that in mind, it has put forward several times, initially in 1976, arrangements  for systematically dismantling MCAs. It was only in 1987, however, that these proposals resulted in  a Council decision. The 'switchover` mechanism, introduced in 1984, represented an important step in this direction.  The Commission believes that the mechanism has led not only to the speedier dismantling of positive  MCAs but paved the way also for the adoption in 1987 of a mechanism for the automatic dismantling  of monetary gaps which the Court itself regards (7.14) as a key element in the abolition of the  agrimonetary system. Furthermore, on the political level, the switchover mechanism has made the fixing of agricultural  prices easier. The Commission is aware, however, of the complexity of the agrimonetary system and of the drawbacks  of the switchover mechanism, in particular its effects on prices. For that reason it is seeking to  reduce those drawbacks and is examining the consequences of abolishing the mechanism as suggested  by the Court (7.3). It is also true that the complexity of the agrimonetary system makes it difficult to obtain an  accurate picture of price movements. It must not be inferred from this, however, that the final  level of common prices is no longer effectively fixed by the Council during the annual agricultural  price fixing operation (7.2). One factor which cannot be controlled by those responsible for making  agricultural policy decisions is the forecasting of currency realignments and their impact on  agricultural prices. Once a currency realignment occurs, however, its effects on prices are  analysed in detail (and the correcting factor referred to in point 2.8 is adjusted); they are taken  into consideration and can be corrected when the common prices are fixed and when decisions are  taken to dismantle the monetary gaps. The effect on the budget is also known. 1. INTRODUCTIONRegarding the conclusions of the Court of Auditors set out in the  introduction to the Report, the Commission here refers to its answers to point 7 entitled  'Principal conclusions and recommendations`. The description of the system of MCAs given by the Court in a significant section of its report is,  generally speaking, correct. 3. THE IMPACT OF GREEN RATES ON THE SYSTEM OF COMMON PRICESVariations in  common price levels3.4(a) The regular adjustments of green rates are made by Council decision. It  is out of the question therefore that a Member State alone can use the system to pursue national  objectives. Green rates and Member States' pricing policy3.7. The reason for the smaller reduction of the  monetary gaps in 1986/1987 for cereals than for animal products was not the extent of the pressure  on farmers' returns. It was possible to dismantle the monetary gaps for animal products by a  greater amount either because there were already production stabilizers in the product area (milk)  or because the intervention arrangements had a generally lower impact on price levels. Therefore  the risk of production being stimulated as a result of a rise in prices in national currency was  less. 3.12. The inconsistency referred to by the Court illustrates the dilemma facing the Commission,  which is confronted, on the one hand, with production policy objectives which entail a price freeze  and, on the other hand, with the need to dismantle monetary compensatory amounts with a view to a  return to an economic situation where there are no barriers to intra-Community trade. Impact on resource allocation3.14(a) The reasoning was correct before the introduction of the  switchover mechanism. In all cases (with the exception of Greece at the moment) the green rates are  higher than the market rates. The size of the gaps continues to vary from one Member State to  another, however, and consequently they have different relative effects. 3.15. Like the Court, the Commission would like to know more about the economic effects of the  agrimonetary system on the market organizations. It has come up against the same problems as the  Court, however, when preparing its four reports. 4. THE SWITCHOVER MECHANISMImpact of correcting factor on common price  level4.7. After each decision on prices - in green ECUs - was adopted by the Council, the true  price in national currency was known immediately by those concerned. 5. THE CALCULATION AND APPLICATION OF MCASMCAs in the pigmeat sector5.7. To  avoid distortions of competition between pigmeat produced in some Member States with low cereals  prices and pigmeat produced elsewhere, the fixing of MCAs for pigmeat was made subject to a minimum  difference of eight points between the monetary gaps for cereals and for pigmeat. The reason for  this eight point rule was the use of substitute products (not subject to MCAs) in certain Member  States. It should be pointed out also that on 30 January 1989, following the price fixing operation for  1988/1989, pigmeat MCAs no longer existed except in Greece. 5.8. The problems in this area are mainly structural ones. The agrimonetary mechanisms have gone  some way towards remedying them. 5.11. The policy pursued has been to limit the application of MCAs to the portion representing the  raw material entering into the production costs for pigmeat. The MCA is calculated therefore on 35   % of the basic price for pigmeat. Neutral margins5.13     5.16. The agrimonetary system is only one of many factors responsible for  changes in trade flows. Among these can be mentioned the currency fluctuations within the band of  2.25  %, in the context of the EMS, the speed of administrative services and the infrastructure of  ports. Processed products5.22. For products known as non-Annex II products, the absence of MCAs could  give rise not only to distortions of trade but also to disturbances on the market as a result of  artificial changes in the composition of products.Care must be taken therefore when considering the  level of the threshold below which MCAs would not be applied. Complexity of the MCA system5.32. The Commission has instructed its staff to simplify rules where  necessary. This applies also to MCA rules. Frauds and irregularities5.35     5.36 On the problem of cattle smuggling across the Irish border  the Commission has carried out on-the-spot inspection visits from February 1986 onwards. Close  examination of the control system governing the movement of cattle from North to South and vice  versa was made and certain weaknesses observed. During a follow-up visit in March 1988 the  documentary control was noted as 'good` and the weaknesses earlier identified seemed to have been  remedied. At the same time it was observed that the incentive for live cattle smuggling did not  currently exist as the MCA gap was narrow. However, as a wide MCA gap existed for cereals a  specific investigation was considered necessary for this commodity. A joint operation relating to  cross-border grain smuggling has been carried out by the Customs Services of the United Kingdom and  Ireland. An interim report on the results is expected by the Commission's staff shortly. 6. THE BUDGETARY IMPACT OF GREEN RATES AND MCASDirect budgetary impact of MCAs  (points 6.1  -  6.4)As regards the charging of MCAs to the budget, Chapter 28 of the budget  contains seven lines on the financial effects of MCAs which are broken not only into  intra-Community trade and trade with non-member countries, but also into import and export  operations. It is true that for trade with non-member countries the budget shows only net expenditure relating  to the MCA mechanism. Where the effect of applying an MCA is to vary the charging of an import levy  or to reduce the grant of an export refund, the net amounts only of the levies and refunds are  recorded in the budget and accounts, and the impact of these reductions is now shown as revenue  (Chapter 10), or as expenditure (Chapter 28). Even though this form of presentation is unsatisfactory from the point of view of strict budgetary  transparency, it was adopted because it was the only one acceptable to all the Member States.  Indeed, when it was introduced some Member States did not indicate that they were able to keep  detailed accounts of two amounts for a single commercial transaction.The method of entering MCAs in the accounts applied in particular by the customs authorities of  certain Member States is to enter the net balance of a transaction where it gives rise to two  payments, one in favour of and the other payable by a single trader. The Commission will study the question of whether a detailed accounting system can be introduced in  all Member States but notes that there would not appear to be economic reasons favouring a change  in the existing accounting arrangements. Indirect budgetary impact of the agrimonetary system dual rate effect (points 6.10  -  6.23)To  avoid any misunderstanding, the Commission is anxious to emphasize that what it has been agreed to  call the 'dual rate effect` does not constitute an expense generated by the agrimonetary system and  concealed in the budget and management accounts as presented at present. The budget, and the management accounts, are drawn up in budgetary ECUs, i.e. in ECUs whose  parities are established on exchange markets. The conversion rate for agricultural products (green  rate) must be regarded as a special unit of account used in the agricultural sector to take account  of the concern to ensure a certain level of prices in national currency. While the use of the green  rate is mandatory for the application of agricultural regulations, only the ECU can be used for  implementing the budget. The dual rate coefficient expresses the relationship between the conversion rate for agricultural  products and the actual rate of the currency concerned. It does not represent intervention in  itself or an autonomous type of expenditure. Separate accounts for this are therefore not possible.  Its impact is very relative, moreover. A revaluation of the central green rates and of the green  rates vis-à-vis the ECU with a simultaneous increase in Community prices in ECUs would produce a  reduction in the effect of the dual rate without any impact on budget appropriations since the  prices in national currency would remain unchanged. The Commission does not therefore interpret the Court's conclusions as meaning that in future  agricultural expenditure should be managed, in terms of both forecasts (budget) and implementation  (accounts), in a unit of account other than that provided for in Article 10 of the Financial  Regulation. If, on the other hand, it is a matter of providing for information purposes an overall estimate of  the dual rate effect, the Commission is prepared to look into the possibility of including remarks  in its preliminary draft budget and in the management accounts. 6.19     6.20. See answer to 5.13 to 5.16. Budgetary impact of the switchover mechanism (point 6.26)In view of the positions which have  always been held within the Council, the hypothesis that price increases expressed in ECUs would  have been smaller because of pressures in favour of a restrictive prices policy would appear to be  ruled out. The change in the agrimonetary system brought about by the introduction of the  switchover mechanism was necessary precisely because this hypothesis had no chance of success. 7. PRINCIPAL CONCLUSIONS AND RECOMMENDATIONSThe Commission is anxious to  reiterate certain views expressed already in the general comments. It believes that the switchover  mechanism (7.2 and 7.3) has helped on the political level to facilitate the annual agricultural  price fixing operation and the adoption of automatic arrangements for the dismantling of monetary  gaps which the Court itself regards as a key element in the abolition of the agrimonetary system  (7.14). While it is true that the complexity of the agrimonetary system can conceal price movements, it  would not be correct to infer from this that the final level of common prices is no longer  effectively fixed by the Council during the annual agricultural price fixing operation (7.2 and  7.6). A factor which cannot be controlled by those responsible for agricultural policy decisions is the  forecasting of currency realignments with their consequences for farm prices. However, when such a  currency realignment is about to take place, its effects on prices are analysed in detail. They are  taken into account and can be corrected when the common prices are fixed and when decisions are  taken to dismantle the monetary gaps. In addition, the impact on the budget is also known. Regarding triangular trade (7.12), the Commission wishes to state that it reacted very promptly  once these practices had been detected. The Commission is aware that the agrimonetary system is complex (7.13). It is endeavouring to  mitigate its drawbacks and is examining ways of abolishing it and the consequences that will  ensue. Market organizations have, admittedly, been disturbed (7.15) by the agrimonetary system but it is a  necessary evil and the question can be put as to what would have happened to market organizations  without those 'disturbances`. This view was also taken by the Court of Justice in the case of  REWE-Zentrale v HZA Kehl as far back as 1973 (). The Commission reaffirms that with a view to the attainment of the large European market in 1992 it  hopes to be able to return to a situation of agricultural price unity. This, however, will demand  progress in other areas (e.g. in economic and monetary integration). Annex IVRationate for 'switchover`1. The switchover mechanism was introduced in 1984 in response  to the fact that it is more difficult generally to dismantle positive MCAs, with or without a  reduction in prices in national currency, than to dismantle negative MCAs.()  Judgment of the Court of Justice of 25 October 1973 in Case 10/73.