Communication from the Commission to the Council -The situation of Germany and France in relation to their obligations under the excessive deficit procedure following the judgement of the Court of Justice
Date: 2004-12-14
Institutions: European Commission
Subjects: France, Germany, budget deficit, budget policy, national budget, sanction (EU), stability pact

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 14.12.2004 
COM(2004) 813 final 

COMMUNICATION FROM THE COMMISSION 
TO THE COUNCIL  

The situation of Germany and France in relation to their obligations under the excessive 
deficit procedure following the judgement of the Court of Justice  

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COMMUNICATION FROM THE COMMISSION 
TO THE COUNCIL  

The situation of Germany and France in relation to their obligations under the excessive 
deficit procedure following the judgement of the Court of Justice   

1. 

BACKGROUND 

Following evidence of general government deficits above 3% of GDP in 2002, the Council in 
the first half of 2003 decided on a recommendation from the Commission that an excessive 
deficit  existed  in  Germany  and  in  France  and  adopted  recommendations  with  a  view  to 
bringing  this  situation  to  an  end  by  2004.  In  the  autumn  of  2003  the  Commission 
recommended that the Council should establish that the actions implemented by Germany and 
France were proving inadequate to correct the deficits and give them notice to take measures 
to  remedy  the  situation.  In  the  light  of  the  weaker  than  expected  economic  situation,  the 
Commission recommended that the deadline for correcting the deficit should be extended to 
2005.  On  25  November  2003  the  Council  voted  on  the  recommended  decisions  but  did  not 
achieve  the  required  majority.  Instead  the  Council  adopted  conclusions  addressing 
recommendations to Germany and France for the correction of the excessive deficit by 2005 
and  stating  that  in  the  light  of  the  commitments  by  the  two  Member  States  the  excessive 
deficit procedure was held in abeyance. The Commission brought a case before the Court of 
Justice  challenging  certain  elements  of  the  Council  conclusions  of  25  November  2003.  The 
Court  delivered  its  judgement  on  13  July  20041.  In  its  judgement  the  Court  annulled  the 
Council  conclusions  in  so  far  as  they  aimed  at  formally  suspending  the  procedure  and 
modifying the existing recommendations. 

In  the  aftermath  of  the  Court  ruling,  the  Commission  stated  that  “the  Commission  in 
cooperation  with  the  Council  will  consider  how  to  ensure  a  satisfactory  resolution  of  the 
budgetary  problems  of  these  two  Member  States  within  the  framework  of  the  Stability  and 
Growth Pact.”2 This Communication serves that purpose. 

2. 

THE  IMPLICATIONS  OF  THE  JUDGEMENT  OF  THE  COURT  OF  JUSTICE  FOR  THE 
EXCESSIVE DEFICIT PROCEDURES CONCERNING GERMANY AND FRANCE 

The Court did not elaborate on the implications stemming from the annulment of the Council 
conclusions of 25 November for the implementation of the excessive deficit procedure.  

In  assessing  the  current  position  of  Germany  and  France  in  relation  to  their  obligations  to 
correct the excessive deficit in accordance with the Treaty and the Stability and Growth Pact, 
it is appropriate to take into account the consequences of the Council conclusions until their 
annulment by the Court. These conclusions benefited from the presumption of validity that is 
attached in principle to every Community instrument. In other words, the two Member States 

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Case C-27/04, Commission of the European Communities v Council of the European Union. 
“Commission  statement  on  the  Court  of  Justice  ruling  relating  to  the  excessive  deficit  procedure”, 
IP/04/897 of 13 July 2004. 

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concerned had the right to assume that measures adopted by Community institutions are valid 
and thus acted on the basis of the Council conclusions. In substance the Council conclusions 
went  along  the  same  lines  of  the  recommendations  of  the  Commission  for  remedying  the 
situation,  specifically,  that  the  deadline  for  the  correction  of  the  excessive  deficit  should  be 
extended  to  2005.  Following  the  adoption  of  the  conclusions,  the  actions  taken  by  the 
Germany  and  France  were  geared  at  meeting  the  deadline  of  2005  set  by  the  Council 
conclusions for the correction of the excessive deficit. These actions have had a factual effect 
on the path of adjustment, which cannot be ignored.  

In  other  words,  while  the  Commission  maintains  its  view  on  the  inadequacy  of  the  actions 
taken  by  Germany  and  France  to  correct  the  excessive  deficit  by  2004,  in  response  to  the 
Council  recommendations  adopted  in  the  first  half  of  2003,  it  recognises  that  the  actions  of 
the  two  Member  States  concerned,  taken  in  the  aftermath  of  the  Council  conclusions  of  25 
November 2003 and up to their annulment by the Court on 13 July 2004 were based on the 
notion that the deadline for the correction of the deficit had been effectively moved to 2005. 

In  the  light  of  the  unique  circumstances  created  by  the  Court  judgement  in  relation  to  the 
excessive deficit procedure concerning Germany and France, in particular, the consequences 
of  the  Council  conclusions  before  their  annulment  by  the  Court,  the  Commission  considers 
that a satisfactory resolution of the budgetary problems of these two Member States within the 
framework of the Stability and Growth Pact demands that the assessment of the actions taken 
to correct the excessive deficit situation should refer to 2005 as the relevant deadline. 

Accordingly the Commission is called to assess whether the actions taken by each of the two 
Member States are consistent with a correction of the excessive deficit by 2005. 

In the affirmative, the Commission would have to conclude that the Council need not take at 
this point further steps under the excessive deficit procedure in order to prompt further actions 
by the Member State concerned. 

In the negative the Commission would have to conclude that the Council needs to resume the 
excessive  deficit  procedure  and  enhance  the  budgetary  surveillance  of  the  Member  State 
concerned in order to prompt the necessary corrective action. 

The  Commission  notes  that  the  Council  itself  in  its  conclusions  of  25  November  2003 
expressed  its  readiness  to  take  a  decision  under  Art.  104(9),  on  the  basis  of  a  Commission 
recommendation,  should  the  assessment  of  the  situation  indicate  a  failure  to  meet  the  2005 
deadline.  

The assessment of the situation in the each of the two Member States is presented in sections 
3 and 4 of this Communication, respectively. Section 5 draws the conclusions on the action 
taken  by  France  and  Germany  and  the  need  for  the  Council  to  take  further  steps  under  the 
excessive deficit procedure. 

3. 

ASSESSMENT OF THE SITUATION IN GERMANY 

The general government deficit is projected by the German authorities to decline from 3.8% 
of GDP in 2003 to 3.7% of GDP in 2004. The Commission Autumn forecast projects the 2004 
deficit at 3.9%. whereas the 2003 update of the stability programme for Germany  projected 
the 2004 deficit at 3.3% of GDP. In contrast, real GDP growth in 2004 is likely to be higher 
than  expected.  In  its  Autumn  forecast  the  Commission  projects  real  GDP  growth  at  1.9% 

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compared  with  1.8%  by  the  German  government.  In  the  2003  update  of  the  stability 
programme  (and  for  the  set-up  of  the  2004  budget),  the  German  authorities  had  expected 
growth  at  1.7%  of  GDP.  However,  GDP  growth  was  driven  by  external  demand,  whereas 
domestic demand remained markedly below expectations. 

The absence of improvement in the 2004 government balance relative to plans despite higher-
than-expected growth is due to the tax-unfriendly composition of GDP growth. Value added 
taxes  and  excise  taxes  like  those  for  mineral  oil  and  tobacco  recorded  substantial  shortfalls 
compared  with  plans.  The  expected  gradual  recovery  in  the  labour  market  failed  to 
materialize, resulting in higher unemployment-related expenditure. Nonetheless, it should be 
noted that in 2004 total expenditure remained constant in  nominal  terms compared with the 
previous year. 

Under the assumption of real GDP growth at 1.5%, the Commission Autumn forecast projects 
the  general  government  deficit  at  3.4%  of  GDP  in  2005.  This  forecast  is  based  upon  a  no-
policy change scenario with the reference date 18 October 2004. On 4 November, the federal 
government  presented  an  additional  savings  package.  In  the  Fiscal  Planning  Council 
(Finanzplanungsrat)  meeting  of  18  November,  the  federal,  state  and  local  levels  of 
government agreed to reduce the general government deficit to 2.9% of GDP in 2005. This is 
based on the government’s projection of real GDP growth at 1.7% in 2005. 

The  additional  savings  package  presented  by  the  federal  government  contains  the  following 
three elements. (i) In 2005, the federal level expects not to incur any expenditure in order to 
cover  a  deficit  of  the  cash  settlement  office  that  settles  the  pension  payments  to  the  civil 
servants  of  the  former  public  post  office  on  behalf  of  the  successor  companies  to  the  post 
office (Postbeamtenversorgungskasse). (ii) An additional global expenditure cut is applied to 
the federal budget. (iii) The federal government will press for no wage increases in the public 
sector in 2005. In addition, (iv) the general government deficit in 2005 will be lowered by a 
repayment  of  subsidies  by  the  Landesbanken  to  the  respective  state  budgets,  following 
Commission decisions of 20 October 2004. 

Compared with the baseline 2005 general government deficit of € 76.6bn (3.4% of GDP) in 
the Commission Autumn forecast, the three measures proposed by the federal government as 
well as the subsidy repayment by the state banks (Landesbanken) are expected to reduce the 
2005 deficit to 2.9% of GDP under a GDP growth scenario unchanged from the Commission 
Autumn forecast. Specifically: 

(i)  The  cash  settlement  office  (classified  in  the  private  sector  by  ESA95)  will  securitise  the 
expected stream of pension contributions from the post office successor companies, which are 
laid down in law. In 2003, the fund paid out pensions of about € 6.5bn and received payments 
from  the  federal  budget  of  €  5.3bn.  The  present  value  of  the  successor  companies’ 
contributions  to  this  settlement  office  is  estimated  at  about  €  13-14bn  (German  Council  of 
Economic  Advisers  Annual  Report  2005).  The  proceeds  from  the  securitisation  by  the  cash 
settlement office are estimated to be sufficient to fully cover its pension payments in 2005 and 
2006.  The  federal  state  would  thus  be  exonerated  from  covering  the  deficit  of  the  cash 
settlement office in those years, which reduces government expenditure, according to ESA95 
rules.  This  measure  is  projected  to  reduce  government  expenditure  by  €  5.45bn  in  2005 
compared  with  the  Commission  Autumn  forecast.  The  German  authorities  have  provided 
Eurostat with detailed information on the nature of the operation. 

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(ii) Federal ministries are obliged to additional global expenditure savings of € 1bn (“Globale 
Minderausgabe”)  in  2005.  In  general,  such  global  savings  are  included  in  the  budget  (i.e. 
reduce  the  planned  deficit),  but  are  not  allocated  to  the  individual  budget  items  (as  the 
individual  sub-budgets  have  already  been  negotiated  between  the  ministries).  For  2005,  the 
federal draft budget presented in June already included a global saving item of € 1.4bn. With 
this  additional  global  savings,  the  amount  planned  as  ‘global  savings’  in  the  budget  would 
now total € 2.4 bn. By way of comparison: the 2004 federal budget included a global saving 
of € 3.3bn, which was respected. This measure is projected to reduce government expenditure 
by € 1bn in 2005 compared with the Commission Autumn forecast. 

(iii) The federal government aims at granting no pay increases for the public service in 2005 
(“Nullrunde”). In  general, the federal government negotiates wage contracts with the  union 
for its employees on behalf of all public employers (i.e. also the states). These agreements are 
then adapted to the civil servants. The last settlement provided for contractual wage increases 
of 1% on 1.1.2004 and again 1% on 1.5.2004; the current contract ends on 31.1.2005. Given 
that  employees  had  to  take  cuts  in  bonus  payments  in  2003  and  2004,  and  the  federal  civil 
servants an extension in working time from 38.5 to 40 hours per week from October 2004, a 
scenario of no pay increases  seems  unlikely. Given the uncertain  outcome produced by this 
measure, the Commission maintains the assumption of a moderate wage increase as included 
in the Autumn forecast. 

(iv) On 20 October 2004, the Commission decided that some transactions made in the early 
1990s by  the Länder with (then) seven Landesbanken constitute illegal subsidies. Given the 
commitment  by  the  Länder  in  the  Fiscal  Planning  Council,  it  is  assumed  that  the 
reimbursement of the subsidies will be booked in the Lander’s accounts in 2005 and that no 
offsetting  subsidies  will  take  place.  This  would  result  in  a  €  4.3  bn  reduction  in  general 
government expenditure in 2005. 

In  sum,  the  Commission  estimates  general  government  expenditure  to  be  reduced  by  € 
10.75bn  (0.5%  of  GDP)  in  2005  compared  with  the  Autumn  forecast.  Ceteris  paribus,  the 
general  government  deficit  is  projected  to  fall  to  €  65.9bn,  equalling  2.9%  of  GDP.  The 
Autumn  forecast  projected  a  reduction  in  the  cyclically-adjusted  deficit  by  0.5  percentage 
point in 2005. Including the additional expenditure reduction, the cyclically-adjusted balance 
would  improve  by  1  percentage  point  in  2005.  It  should  be  noted  that  the  pension  fund 
transaction is expected to relieve the federal budget of expenditure by 0.25% of GDP also in 
2006. Ceteris paribus, this would bring the projected 2006 deficit from 2.9% down to 2.6% of 
GDP  compared  with  the  Autumn  forecast.  However,  none  of  the  above  items  are  structural 
reforms  with  long-term  benefits.  The  reduction  of  expenditure  to  the  cash  settlement  office 
shifts an implicit liability to the future, the global savings cut is an ad hoc measure and the 
subsidy  repayment  a  one-time  windfall  gain.  Any  unfavourable  development  on  the 
macroeconomic  or  on  the  budgetary  side  could  bring  the  deficit  above  3%  in  2005.  Should 
such  unfavourable  developments  occur,  the  implementation  of  further  additional  measures 
would be necessary to secure the correction  of the excessive  deficit  situation in 2005  at  the 
latest.  

The improvement in the macroeconomic and budgetary situation in 2005 would however not 
be sufficient to bring the debt ratio on a declining path. The Commission projects that the debt 
ratio  will  rise  to  67.1%  of  GDP  in  2006.  Since  thereafter  implicit  liabilities  from  these 
measures increase, the Commission does not expect a decline in the debt ratio after 2006. The 
budgetary  situation  of  Germany  remains  vulnerable  and  the  need  for  structural  budgetary 
adjustments all the more pressing. 

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Germany Commission Autumn 2004 forecast amended by the additional measures 

Real GDP growth (% change) 
General government balance (as a % of GDP) 
Cyclically-adjusted balance (as a % of GDP) 
General government revenues (% of GDP) 
General government expenditure (% of GDP) 
General government gross debt to GDP ratio 

2003 
-0.1 
-3.8 
-3.0 
45.0 
48.8 
64.2 

2004 
1.9 
-3.9 
-3.4 
43.5 
47.5 
65.9 

2005 
1.5 
-2.9 
-2.4 
43.2 
46.1 
66.7 

2006 
1.7 
-2.6 
-2.1 
43.0 
45.6 
67.1 

Projections are based on the assumption of an unchanged policy. Figures may not add up due to rounding. 

4. 

ASSESSMENT OF THE SITUATION IN FRANCE 

The general government deficit is projected by the French authorities to decline from 4.1% of 
GDP  in 2003 to  3.6%  of GDP in 2004. This  is  in  line with the initial target set in the draft 
Budget  for  2004.  Respect  of  the  deficit  objective  in  2004  was  facilitated  by  a  clear 
improvement  in  the  macroeconomic  situation  relative  to  Budget  projections:  the  French 
authorities currently expect real GDP growth at 2.5%, as against 1.7% in the draft Budget for 
2004.  In  its  Autumn  2004  forecast,  the  Commission  projected  the  2004  deficit  at  3.7%  of 
GDP, under the assumption of real GDP increasing by 2.4%. 

The absence of improvement in the 2004 deficit relative to plans despite higher-than-expected 
growth is due to some adverse developments. Notably, in April the 2003 deficit estimate was 
revised  upward,  causing  a  negative  base  effect  (0.1%  of  GDP).  In  May,  the  Conseil  d’Etat 
partly  cancelled  a  reform  of  the  unemployment  insurance  system  that  foresaw  a  substantial 
tightening of eligibility conditions (0.1% of GDP). Finally, health and local expenditure were 
higher than planned (0.1% of GDP). 

Assuming real GDP growth at 2.5%, the draft Budget for 2005 foresees a decline in the deficit 
from 3.6% of GDP in 2004 to 2.9% of GDP. The deficit reduction is projected to result from 
expenditure restraint and a significant increase in revenues. Expenditure restraint is planned to 
stem notably from (i) the stabilisation of State expenditures in real terms for the third year in a 
row  and  (ii)  a  clear  slowdown  of  health  expenditure  resulting  from  the  first  effects  of  the 
comprehensive reform of the health insurance system adopted in Summer 2004. The increase 
in  the  revenue-to-GDP  ratio  would  reflect  (i)  the  impact  of  discretionary  measures  on  the 
fiscal  side3  (0.1%  of  GDP)  and  (ii)  a  one-off  payment  linked  to  the  transfer  of  the 
responsibility  for  the  payment  of  pensions  of  the  employees  in  public  electricity  and  gas 
companies  to  the  social  security  sector.  Since  the  presentation  of  the  draft  Budget  in 
September, this one-off payment has been revised slightly upward (by 0.1% of GDP to 0.5% 
of GDP). 

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The  tax  increases  decided  in  the  context  of  the  reform  of  the  health  insurance  system  will  more  than 
compensate  for  the  tax  cuts  announced  in  the  context  of  the  draft  Budget  for  2005  and  for  the  tax 
exemptions  on  interest  payments  on  consumer  credits  and  on  inter-generational  financial  transfers 
announced in May 2004. 

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The improvement in the budgetary situation in 2005 would not be sufficient to bring the debt 
ratio on a declining path. According to the multi-annual projection attached to the Budget, the 
debt  ratio  would  start  declining  in  2006.  In  that  year,  despite  the  vanishing  of  the  one-off 
revenues of 2005, the general government deficit would be brought to 2.2% of GDP.  

The Commission services autumn 2004 forecasts show a general government deficit at 3.7% 
of GDP in 2004 and 3.0% of GDP in 2005. The slight difference between the Commission’s 
and  the  French  authorities’  deficit  forecasts  for  2005  results  from  two  factors:  (i)  the 
macroeconomic  projection  of  the  Commission  is  more  cautious  than  that  of  the  French 
authorities: the Commission projects real GDP growth at 2.2% in 2005 as against 2.5% for the 
French  authorities;  and  (ii)  although  considering  that  the  reform  of  the  health  insurance 
system  is  likely  to  trigger  substantial  savings  in  the  medium  run,  the  Commission  is  more 
cautious on the impact of the reform in the short term. The cumulated negative effect of these 
two factors (0.2% of GDP) is only partly compensated by the fact that, based on information 
provided by the French authorities, the one-off revenues included in the Autumn Commission 
forecast are slightly larger than those included in the forecast of the draft Budget (by 0.1% of 
GDP).  According  to  Commission  calculations  based  on  its  Autumn  forecast,  the  cyclically-
adjusted deficit will be reduced by 0.7 percentage point of GDP in 2005, 0.5 percentage point 
of which reflects the impact of one-off measures. 

the  Commission,  any  unfavourable  development  on 

The  budgetary  situation  of  France  remains  however  vulnerable.  Given  that  the  deficit  is 
projected to be reduced only marginally below 3% of GDP by the French authorities and to 
exactly  3%  of  GDP  by 
the 
macroeconomic or on the budgetary side could be sufficient to bring the deficit above 3% and 
therefore compromise the achievement of the objective of correcting the excessive deficit in 
2005  at  the  latest.  In  addition,  the  deficit  reduction  in  2005  largely  relies  on  the  favourable 
impact  on  2005  budgetary  statistics  of  a  measure  that  is  broadly  neutral  for  the  underlying 
situation  of  French  government  finances.  Indeed,  while  the  transfer  of  the  responsibility  for 
the payment of pensions of the employees in public electricity and gas companies to the social 
security implies a big lump sum payment to the general government in 2005, it also implies 
additional expenditure in the subsequent years for a comparable cumulated amount since the 
social security will have to pay the future pension benefits to the employees of the electricity 
and gas sectors. The temporary nature of this measure is reflected in the Commission deficit 
forecast for 2006, which, under the assumption of an unchanged economic policy, projects an 
increase in the deficit to 3.3% of GDP. This means that further consolidation measures will 
have to be taken in order to avoid another breach of the 3% of GDP ceiling in 2006. 

France Commission forecast, Autumn 2004 

Real GDP growth (% change) 
General government balance (in % of GDP) 
Cyclically-adjusted balance (in % of GDP) 
General government revenues (% of GDP)  
General government expenditure (in % of GDP) 
General government gross debt (in % of GDP) 

2003 
0.5 
-4.1 
-3.8 
50.5 
54.7 
63.7 

2004 
2.4 
-3.7 
-3.5 
50.5 
54.2 
64.9 

2005 
2.2 
-3.0 
-2.8 
50.9 
53.9 
65.5 

2006 
2.2 
-3.3 
-3.1 
50.4 
53.8 
66.3 

Projections are based on the assumption of an unchanged policy. Figures may not add up due to rounding. 

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5. 

CONCLUSIONS  

In  the  light  of  the  unique  circumstances  created  by  the  Court  judgement  in  relation  to  the 
excessive deficit procedure concerning Germany and France, in particular, the effects of the 
Council  conclusions  of  25  November  2003  before  their  annulment  by  the  Court  on  13  July 
2004,  the  Commission  reaches  now  the  following  conclusions  on  the  situation  of  the  two 
Member States concerned. 

As regards Germany, on current information and on the basis of the measures detailed in the 
2005 budgetary plans and the additional savings package announced by the Government on 4 
November 2004, it appears that actions taken by the German authorities are broadly consistent 
with  a  correction  of  the  excessive  deficit  by  2005.  Accordingly,  the  Commission  concludes 
that no further steps are necessary at this point under the excessive deficit procedure. 

As  regards  France,  on  current  information  and  on  the  basis  of  the  measures  detailed  in  the 
2005  budget,  it  appears  that  actions  taken  by  the  French  authorities  are  broadly  consistent 
with  a  correction  of  the  excessive  deficit  by  2005.  Accordingly,  the  Commission  concludes 
that no further steps are necessary at this point under the excessive deficit procedure.  

The Commission notes that the budgetary situation in each of the two Member States remains 
vulnerable. Correction of the excessive deficits demands effective implementation of all the 
measures  envisaged.  Should  failures  in  implementing  the  envisaged  correction  emerge  at  a 
later  stage,  the  Commission  would  have  to  recommend  to  the  Council  to  enhance  the 
budgetary  surveillance  and  to  take  the  necessary  action  within  the  provisions  of  the  Treaty 
and the Stability and Growth Pact. 

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