EU discontent over French budget deal's 'political bazaar'

By Jan Strupczewski BRUSSELS (Reuters) - France, Germany and the European Commission believe leaving Paris unpunished for persistently failing to curb its budget deficit was a wise compromise that bolsters the euro. But it takes little effort to find EU officials who say it sends a signal to governments and investors that rules set to hold the common currency together are bankrupt. That, they fear, may make it harder for the euro to weather a future crisis. "The rules are hardly comprehensible," Jens Weidmann, head of the German central bank, said last week. "And the implementation is like some political bazaar." In Brussels this week, German Chancellor Angela Merkel and Commission President Jean-Claude Juncker spoke with one voice. France's budget was "on the right track", Merkel said, and the deal sound. But Berlin officials acknowledge politics lie behind it. To embarrass President Francois Hollande would fuel anti-EU rivals such as the far-right National Front. Inside the EU executive, officials talk privately of disagreement at the top over last week's decision to grant the bloc's second largest economy a further two-year grace period to get its deficit in line with the rules. Some speak, too, of disillusion among EU technicians who see big power politics trumping their careful analysis of French budget plans. None will speak publicly against a deal that Paris says is vital to avoid prolonging years of stagnation. One official in Brussels told Reuters a Commission note in January on how far the regulations, known as the Stability and Growth Pact, could be bent in a recession had fatally undermined rules meant to force states to run the harmonized economic policies required in a single currency area. "With the decision not to punish France for missing targets the Commission has now killed off the corrective functions as well," the official said of last week's decision not to impose a fine on Paris that could have been as much as 4 billion euros. Christoph Weil, an economist at Commerzbank, agreed: "You can forget the Stability and Growth Pact," he said. "It's dead." The euro zone has long struggled to reconcile the needs of different economies. If investors see rules intended to limit divergence are not enforced, expectations of an eventual break-up may rise. Hollande and Italy's Matteo Renzi have pushed for a focus on growth over debt-cutting and some policymakers, such as Eurogroup head Jeroen Dijsselbloem, have been willing to discuss budgetary leeway in return for countries pursuing structural economic reforms. Many economists argue that with France able to borrow for five years for virtually nothing and investors paying for the privilege to lend to Germany over the same timeframe, now is the perfect time to borrow to invest, boosting growth and tax receipts which will bring debt down over time. But the prevalent view in Brussels is that France has not tackled reforms in the way Germany did over a decade ago. The EU official said Italy and Belgium, which were under the microscope alongside France, had submitted impressive reform plans to the Commission. "France had done nothing," the official said. French Finance Minister Michel Sapin said he could understand how some in Brussels might be "irritated", but that France's large share of euro zone GDP had to be weighed in the balance. "That is true for us and it is true for Germany and in some ways for Italy and Spain," he told reporters in Paris on Thursday. "Those four countries are the heart of the euro zone ... You've got to look out a bit for them." Such special pleading for big countries could be particularly infuriating for smaller ones at a time when the euro zone, and Germany in particular, have been playing hardball in a different context over bailout talks with Greece. CONTORTED To justify not fining Paris, the Commission had to conclude France - the co-creator of the euro with Germany - had taken effective action to cut its budget gap in 2013 and 2014. Officials told Reuters the analysis underlying that decision was contorted to fit the end result. "The available evidence does not allow to conclude on no effective action," was the Commission's hesitant conclusion. France's budget deficit was 4.1 percent of GDP in 2013, 4.3 percent in 2014 and will be at 4.1 percent again this year, well above the EU limit of three percent of national income which France now will have until 2017 to reach. The European Central Bank is certainly concerned. This was its president, Mario Draghi, speaking to reporters on Thursday without naming offending countries: "Decisive implementation of product and labor market reforms and actions to improve the business environment for firms need to gain momentum in several countries," he said. "It is crucial that structural reforms be implemented swiftly, credibly and effectively." The French government argues deeper cuts would have killed off a tenuous recovery in an economy that it is quietly starting to overhaul in the face of stiff opposition. The government is pushing through reforms, which include making it easier to hire and fire, broadening trading hours and deregulating some sectors. They are modest by the standards of many EU countries but have sparked revolts from left and right, including within the ruling Socialist party. Despite a united front in public, the France decision, taken at a meeting of the commissioners from all 28 EU states last Wednesday, was not welcomed by all. Some of those present argued against leniency, EU sources said. But Pierre Moscovici, Hollande's former finance minister who is now the EU economic commissioner, was against a fine and he found support from Juncker for a ruling that gave France more time and left open the possibility of sanctions later on. Such a decision would not have been possible had Germany not quietly given its consent, EU officials said, noting Berlin's concern over Hollande's unpopularity and the rising challenge of the anti-EU National Front of Marine Le Pen. "Their overriding principle now is 'don't kick a man when he is down'. And Hollande is still down," a senior euro zone official said. "The shadow of Le Pen has not disappeared." The euro zone has form in allowing its dominant members to break the debt rules. France and Germany both did so in 2003, irritating smaller states. They have since been tightened, following the debt crisis that threatened the project. "At the first real test of the new rules, Europe is falling into its old habits and waiving any sanctions," said Teunis Brosens, economist at ING bank. "It does not really motivate any government to be prudent in the future ... I doubt today's experiences will lead us to the next crisis, but they will complicate it." (Additional reporting by Robin Emmott in Brussels and Jean-Baptiste Vey in Paris. Editing by Alastair Macdonald/Mike Peacock)