This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 THE HAGUE 001697 
 
SIPDIS 
 
STATE FOR A/S WAYNE, EUR P/DAS RIES, EB DAS BAY 
 
STATE ALSO FOR EUR/ERA, EB/IFD/OMA 
 
STATE ALSO FOR EUR/UBI/MNORMAN 
 
TREASURY FOR U/S TAYLOR, A/S QUARLES, DAS SOBEL 
 
TREASURY FOR OASIA/IMI/RENEEMATHIEU 
TREASURY ALSO FOR OASIA-HARLOW, AUSTIN 
TREASURY ALSO FOR OCC-MCMAHON 
 
WHITE HOUSE FOR CLOUD 
 
ROME FOR ECON-MILLIKEN, DOHERTY 
 
FRANKFURT FOR TREASURY/WALLAR 
 
BRUSSELS FOR USEU/ECON-BROWN 
 
E.O. 12356:  N/A 
TAGS: EFIN NL ECON EUN
SUBJECT:  The Netherlands' EU Stability Pact Dilemma 
 
REF:  USEU Brussels 3255 
 
¶1.  This message was jointly drafted by Embassy The Hague 
(Econ-Schultz), USEU Brussels (Econ-Brown), and ConGen 
Frankfurt (Treasury-Wallar) 
 
¶2.  Summary.  The Netherlands' proposed EU stability program 
to be considered by the Ecofin Council July 14-15 is based 
on outdated numbers and presents a more optimistic outlook 
than more current forecasts.  Finance minister Gerrit Zalm 
will have to confront slow growth and a growing deficit over 
the next two years that risk breaching the EU Stability and 
Growth Pact, jeopardizing the EU's "close to balance" target 
for 2007, and spotlighting Zalm's reputation as the 
Council's hard man on fiscal deficits.  Self-imposed EMU 
deficit targets agreed in the Dutch government's coalition 
accord commit the center-right coalition to take measures 
when these targets are breached.  In view of rapidly 
deteriorating economic growth prospects, budget 
retrenchments needed to redress the deficit problem seem 
unavoidable unless the deficit targets in the coalition 
accord are abandoned.  Finance Minister Gerrit Zalm held 
fast to his principles at the June Ecofin in objecting to 
lenient treatment for France under the Pact's excessive 
deficit procedure.  He will find it difficult to be as tough 
on the dutch government budget performance if the Dutch 
economy hits the skids predicted by these current forecasts. 
End summary. 
 
¶3.  New forecasts conflict with the assumptions underlying 
the Netherlands' revised EU stability program, due to be 
considered by member state finance ministers at the July 14- 
15 Ecofin Council.  The numbers threaten to confront Finance 
Minister Gerrit Zalm with a dilemma he never had to face 
during eight years of economic upturn:  slow growth and a 
rapidly growing deficit. 
 
¶4.  The revised Netherlands' economic outlook for 2003-2004 
 
                         2003           2004 
                         (y/y percentage change) 
GDP                       0              1.25 
Consumption               0.5            1 
Investment               -3.5           -0.5 
Exports                   0.5            5 
Inflation                 2.25           1.25 
Unemployment              5.5            6.75 
                         (percent of GDP) 
EMU-Deficit              -1.9           -2.6 
 
¶5.  The Hague Economic Officers and Senior Economic Adviser 
discussed the Dutch program with European Commission and 
Dutch permrep officials June 19 in Brussels.  The European 
Commission's assessment of the Dutch proposal, the final 
country report in the EU's annual stability/convergence 
program exercise, forecast improving growth and a falling 
deficit.  It is based on assumptions of 0.75 per cent GDP 
growth in 2003 increasing to 2.5 percent in 2007, leading to 
a nominal general government deficit of 1.6 per cent of GDP 
in 2003, 1.7 percent of GDP in 2004, and a 0.5 percent 
"close to balance" deficit target for 2007. 
 
¶6.  However, Council consideration of the report has been 
delayed because of the Dutch May 2003 general elections and 
the following change in government.  Not surprising, the 
growth assumptions on which it is based have been overtaken 
by events.  In the interim, a bleaker than expected outlook 
for a recovery of world trade growth has led to recent 
downward revisions of GDP growth forecasts varying from 
stagnation (official Bureau for Economic Policy Analysis 
(CPB) and major commercial banks) to a 0.4 percent fall in 
GDP in 2003 followed by 1.25 percent growth in 2004 (recent 
Netherlands Central Bank forecast).  The leaked, but yet 
unconfirmed, CPB scenario predicts a drop in tax revenues to 
catapult the nominal deficit to 1.9 per cent (10 billion 
euros) in 2003 and to 2.6 per cent (13 billion euros) in 
¶2004.  As a result, the budget deficit in 2007 increases to 
0.9 percent of GDP, well away from the EU's 0.5 percent 
"close to balance" target. 
 
¶7.  The growing deficit forecast could lead to two serious 
consequences by the end of 2004: 
 
o    A fiscal deficit only 0.4 percentage points below the 3 
     per cent ceiling mandated by the EU Stability and Growth 
     Pact; and 
 
o    Exceeding the 2.5 per cent self-imposed EMU deficit 
     ceiling contained in the recently-published Government 
     Coalition Accord. 
 
¶8.   Zalm's options appear to be limited.  He can: 
 
o    Let the deficit run its course, stick to the hefty 13.1 
     billion euro consolidation package announced in the 
     Coalition Accord and avoid the negative effects on GDP 
     growth of further spending cuts or tax increases; or 
 
o    Propose further measures (spending cuts and/or tax 
     increases) to steer the deficit away from the government- 
     accord and Stability Pact deficit ceilings and thus cause a 
     drag on growth 
 
¶9.  Under the first option, the Netherlands risks joining 
Portugal, Germany and France in the Stability Pact's "sin 
bin", the excessive deficit procedure.  This could dent 
Zalm's reputation among his fellow finance ministers as "Il 
Duro" (the tough one).  If, on the other hand, economic 
recovery in 2004 would help steer the deficit back on course 
towards balance, Zalm would not have to react immediately. 
He would, however, be prepared for additional deficit 
reduction should economic recovery not take hold in the 
second half of 2003. 
 
¶10.  Under the second option, Zalm would have to propose 
cutting spending by another 0.1 percentage point of GDP (0.5 
billion euro on top of the 13.1 billion euro consolidation 
package already agreed) in order to reduce the deficit in 
2004 from 2.6 to the self-imposed 2.5 percent deficit target 
in the coalition accord.  But should the coalition- 
government stick to its goal to reduce the deficit during 
the next four-year period by an accumulated 1.8 percent of 
GDP to reach the EU's close-to-balance criteria in 2007, 
Zalm would have to take extra measures to the tune of at 
least 4 billion euro (0.4 percent of GDP).  This would risk 
putting a damper on public spending and investment, serving 
as a possible drag on economic recovery.  Raising taxes to 
bring the budget towards balance does not seem an option at 
the moment.  It would strike at the roots of one of the 
objectives in the coalition accord of reducing the general 
(tax) burden to help raise the Netherlands' long-term growth 
potential. 
 
¶11. Dutch PM Jan-Peter Balkenende admitted June 28 that 
extra measures to keep the deficit increase at bay, should 
the bleaker economic outlook hold, are unavoidable. 
Balkenende remained vague about the magnitude or the nature 
of additional budget measures.   Although the Dutch PM 
agreed that sticking to the coalition accord deficit 
reduction target would require draconian spending cuts, he 
did not want to speculate about the possibility of 
abandoning the target.  Finance Minister Gerrit Zalm held 
fast to his principles at the June Ecofin in objecting to 
lenient treatment for France under the Pact's excessive 
deficit procedure (reftel).  He will find it difficult to be 
as tough on the Dutch government's budget performance if the 
Dutch economy hits the skids predicted by these current 
forecasts. 
 
¶12. Since additional cuts in spending are hard to find or 
are politically sensitive, pressure on labor unions to 
observe wage moderation, as an alternative means to cut 
spending, is likely to increase.  Wage moderation is seen as 
having double benefits: reducing the wage bill in the public 
sector would narrow the deficit gap, and reducing it in the 
private sector would help to restore the seriously eroded 
Dutch competitive position.  Whichever route the center- 
right coalition chooses to go to meet its EU and EMU budget 
commitments it is likely to create political unrest and 
affect business and consumer sentiment.  Recent surveys show 
that public anxiety about the deterioration of public 
finances and opposition to the proposed spending cuts is 
rapidly growing. 
 
SOBEL