In a marathon session Sunday night, EU finance ministers agreed to exclude the cost of German reunification in the calculation of German deficits, a major stumbling block in negotiations since last fall.

German Finance Minister Hans Eichel, who had lobbied hard for the exemption told news agency AFP that "no one else has had to undertake a (financial) challenge as big as reunification."

Germany, the EU's biggest economy, has for the past three years violated the Stability and Growth Pact's rules that stipulate that no eurozone member's public debt should exceed 3 percent of gross domestic product.

At the same time, Germany, the largest net contributor to the EU budget, has spent hundreds of billions of euros on reunification. It is also the EU'S poorest performing economy, having narrowly escaped its third recession in four years and having an unemployment rate of 12.6 percent. The agreement will allow Germany to discount about 4 percent of its GDP when tallying its deficit.

Still, not all German officials were happy with the agreement.

"We are leaving future generations with more debt and higher taxes," CDU financial expert Michael Meister told German television channel ARD. "And this is not going to be good for employment creation."

Strained credibility

The 1997 budget pact was all but suspended in November 2003 when EU heavyweights France and Germany were let off the hook despite repeatedly breaching a key requirement. Since then nearly half the EU's 25 states have also triggered disciplinary measures under the pact, while the system's already-strained credibility has also suffered after it emerged that Greece had submitted wrong data for years.

Until now an agreement had been kept at bay by deep divisions between countries wanting more flexibility, led by France and Germany, and other, mostly smaller, nations such as Austria and the Netherlands wanting the principles of budgetary discipline to be upheld.

Now the EU is determined to renew the budget rules in a way that will not threaten economic recovery and will strike the right balance between budgetary rigor and fiscal flexibility.

EU leaders maintain that the pact's two key rules - public deficits should not exceed 3 percent of gross domestic product and public debt should not surpass 60 percent of GDP - were not compromised. They are "neither in question nor threatened" by the agreement, Luxembourg Prime Minister Jean-Claude Juncker, whose country holds the EU's presidency, told AFP. "I am satisfied with the agreement, the fundamental rules ... have not been changed."

Instead, the deal boosted measures aimed at preventing countries from overspending as well as reinforced the authority of EU's executive commission to police the deficits, he said.

The agreement also allows countries more time to rein in their deficits when they overshoot the three percent limit and it requires the European Commission to take into account extraordinary circumstances when judging a member's deficit.

Final approval is expected during the summit this week.

Not a free ride

The European Commission, which polices deficits, voiced satisfaction with the outcome of the talks with EU economic affairs commissioner Joaquin Almunia saying he had a "very positive view of the final result."

However, Austrian Finance Minister Karl-Heinz Grasser, who has led a campaign against watering down the pact, expressed muted satisfaction.

"It is not the best solution I can imagine, but I am confident that it is a result that can guarantee stability-oriented fiscal policy in the European future," he said. "But it is not a free ride, it is not carte blanche for deficit spending."