EU signals flexibility on budgets, aiding France, Italy

BRUSSELS (Reuters) - The European Commission said on Tuesday that public investment and structural reforms could win some leeway for countries breaking EU budget rules, reducing the likelihood of tough penalties on France or Italy.

The Commission's interpretation of the rules is a balancing act between retaining the confidence of financial markets and responding to EU leaders who want to use whatever flexibility there is in the rules to help boost meager economic growth.

The rules, called the Stability and Growth Pact, underpin the euro by preventing excessive borrowing by governments. They set the maximum budget deficit at 3 percent of GDP and debt at 60 percent of GDP -- anything above is considered excessive.

The Commission, as the guardian of EU law, has to make sure EU governments, and those sharing the euro in particular, play by the rules. It can start legal steps, that can end in fines, against governments which borrow too much.

France, the second biggest economy using the euro, has been running a budget deficit well above the 3 percent limit for years and, having done little to reduce it despite promises of change, could now be facing a fine of up to 4.2 billion euros.

The Commission will decide if Paris should be fined in early March. Italy, even though its deficit is smaller than 3 percent, has a very large and rising public debt and could face disciplinary action for not reducing it.

Rome also does not want to reduce its deficit toward balance as fast as EU rules say.

Both countries have called for more time to consolidate public finances, arguing that harsh steps now would only make matters worse for their economies -- contracting in the case of Italy and barely growing in the case of France.

In response Commission published on Tuesday a report, spelling out what leeway EU countries can count on when the EU executive arm assesses their fiscal efforts.

"We are providing an interpretation of the Stability and Growth Pact, we are not changing or amending any of the rules of the Pact," Valdis Dombrovskis, Commission vice-president for the euro told Reuters in an interview.

"We are looking how in the Stab Pact we can best promote structural reforms and investment and how to look at the economic situation in the member states."

(Reporting By Jan Strupczewski; Editing by Alastair Macdonald)