-- Paul Taylor is a Reuters columnist. The opinions expressed are his own --
By Paul Taylor
PARIS, June 4 (Reuters) - Why does the European Union stick with a set of rules on public debt and deficits when it is clear that none of the biggest member states is going to obey them for the foreseeable future?
It beggars credibility to recite the Stability and Growth Pact mantra of limiting deficits to 3 percent and public debt to 60 percent of gross domestic product when all indicators are pointing in the opposite direction as far as the eye can see.
In the real world, Germany's budget deficit is forecast to hit 5.9 percent of GDP next year, France's 7 percent, Britain's 13.8 percent and Ireland's 15.6 percent, due to economic stimulus spending, extra welfare costs and a recession-induced fall in revenue. The European Commission estimates government debt in the euro area will average nearly 84 percent in 2010, with an average public sector deficit of 6.5 percent of GDP.
It will take years of painful public spending cuts and tax increases to bring those deficits anywhere near the EU ceiling, let alone reach the medium-term objective of balanced budgets. Given the unpopularity of austerity, some governments are already tiptoeing away from even trying.
Since the key targets are anchored in EU treaty law, they cannot simply be swept away. But market forces may prove more effective than European rules in putting governments back on the path to fiscal discipline. Debt markets have begun to levy a risk premium on the debt of states such as Greece, Ireland, Spain or Italy compared to benchmark German bonds. This did not occur during the single currency's first decade. Dublin fears that bond vigilantes may soon be on the warpath.
There is another reason for continuing to pay lip service to the rules -- even if everyone is breaking them. The EU insists that east European countries wishing to join the euro zone must strictly meet the Maastricht Treaty debt and deficit criteria, as well as achieve sustainable low inflation and keep their currencies stable against the euro for two years.
Indeed, existing euro members seem more determined than ever to enforce the letter of the law on applicants, perhaps because Ireland's meltdown has taught them that even small economies can potentially put the currency zone's stability at risk. They feel the currency area has enough to do juggling the interests of 16 members through a once-in-a-lifetime financial crisis and recession. The last thing they want is a flood of refugee countries joining the euro bloc.
Attempts to inject more realism into the lala land of European fiscal policy are met with temporising or denial. EU Monetary Affairs Commissioner Joaquin Almunia argues the rules should simply be applied flexibly and countries should be given a bit longer to bring deficits down to the reference level. The European Central Bank says fiscal discipline must be restored as soon as possible and the euro zone entry rules must not be bent.
This presages the mother of all battles next year when the Germans and the ECB declare the recession over and say it's time to get back on the straight-and-narrow, while the French point to mass unemployment and the danger of choking off the recovery.
French Finance Minister Christine Lagarde fired the first shot this week by suggesting that debts and deficits incurred during the financial crisis should be handled separately from "structural" shortfalls, like "good" and "bad" cholesterol.
Lagarde's idea -- she admitted she had not fully thought it through -- looks like a Gallic accounting ruse with an eye to France's 2012 presidential election. Debt markets would likely see through it and punish states with persistent high deficits by charging higher long-term interest rates.
But at least she had the merit of opening an overdue debate on how to reconcile the EU's rules with reality and end the hypocrisy of applying them more rigorously to non-members than to members of the euro zone.
The EU has already loosened the regulations once, in 2005, after Germany and France repeatedly breached the original Stability Pact until it had to be suspended. Helped by market pressure, EU finance ministers now need to forge a consensus on how to apply the deficit rules consistently to euro "ins" and "outs", be they great or small.
The outcome is likely to be some promise of future virtue. That might entail a two-year moratorium on deficit reduction with a commitment to narrow the gap by at least 0.5 percent of GDP a year thereafter, and a shortening of the euro entry path for candidates. States under the fiercest market pressure will want to do more voluntarily to improve their credit rating.
Whatever euro zone politicians decide, the bond vigilantes may yet have the final word. (editing by David Evans)