Mary Harney believes we still have a successful economy and if we pursue the correct policies, which excludes income tax rises, we will remain successful, she tells Arthur Beesley.

The Government should have adopted a different approach to the disclosure three weeks ago of an Exchequer deficit, the Tánaiste has said. Defending the State's economic record but adding that aggressive spending cuts were required in the Budget, Ms Harney said news of the deficit could have been handled better.

A little more than a week before the second Nice referendum, Ms Harney also said voters should endorse the treaty, stating that another No vote would be interpreted internationally as a rejection of Europe.

She said: "Certainly, if companies form the impression, which they would, that a rejection of Nice was a rejection of Europe - and if Europe is thrown into disarray because of uncertainty about what would happen next, I think that would be bad for us and bad for investment here and I think our competitors would use it very strongly against us."

In an interview, she also called for an agreement on pay between employers and unions in the new round of partnership talks and said the Government was looking to the private sector to part-fund major transport initiatives such as the proposed Metro in Dublin.

If Ms Harney's first term as Tánaiste was marked by heady economic growth, her return to office this summer came as the slowdown began to bite.

Yet while she accepts that the next two years will be "very tough", she says the economy was still growing faster than anywhere else in Europe.

Despite job losses and the cancellation this week of a major project in Co Longford, she said the unemployment rate of 4.3 per cent was akin to full employment.

"There's no crisis in the economy," she said.

"I would be very optimistic provided we have our eye on the ball and not just that we manage our way through this very cautiously and prudently but that we're seen to do it as well."

For that, however, she said spending growth more appropriate to a rapidly growing economy could not be maintained. In addition, borrowing for capital purposes was likely.

Ms Harney said: "You have to take a prudent approach. You don't lightly borrow even for capital purposes, but I think for specific capital projects it makes sense to borrow."

While the Department of Finance last week revealed a €750 million deficit this year, news that Government spending was outpacing revenues had emerged in a confidential memo mistakenly released to a Sunday newspaper.

Ministers had claimed the public finances were in surplus and the deficit prompted accusations that the Government had misrepresented the situation during the General Election. In advance of the Flood tribunal report, it was probably the first occasion since the election in which the Opposition landed a punch against the Government.

Ms Harney said: "I think the manner in which we may have handled things over the last few weeks isn't what it could have been or should have been, in that we probably needed to give people more information and perhaps talk more with the public."

With preparations for the Budget Estimates nearing competition this month, Ms Harney gave a strong signal that health spending would increase and that she would seek a rise in the Third World development budget and in funding for science and technical research.

But the squeeze in the public finances meant expenditure in certain areas would be scaled back while increases in the indirect taxation of the "old reliables" were also likely.

Ms Harney said: "On the taxation front, I would not support any increases in personal tax levels or any change in the corporation tax."

There was, however, little likelihood of any generalised income tax reduction, long a core Progressive Democrat policy.

Any such measure would be geared towards minimum wage workers.

She added: "The big challenge for us is going to be on the spending side. In order to meet our political priorities we will have to reduce spending in some areas and increase them in the areas that are a priority for the Government."

Ms Harney declined to specify what areas of expenditure were at risk but said Ministers were looking "fairly aggressively and realistically" at all items.

She said: "We'll be looking at a whole host of options and it will be a matter for us to make choices and be very focused on the things that are important. ... I think the reality is that we still have a very successful economy and if we pursue the appropriate policies we will remain successful."

The Minister for Enterprise, Trade and Employment when double-digit growth became almost the norm, Ms Harney said the scene had changed fundamentally from when she joined the Department in 1997. This imposed new policy requirements on Government with the political priority for Ms Harney shifting to the fostering of competition for services as prices rise.

The Tánaiste said she would bring proposals to reform the insurance business to Cabinet in the next fortnight. While there had been criticism by lawyers particularly of plans to establish a Personal Injuries Assessment Board (PIAB) to assess minor awards for damages, Ms Harney said this was just one of the measures she wanted to introduce.

The Competition Authority embarked this week on a study of the sector with her Department and Ms Harney said she wanted Government approval to seek particular premium reductions by the end of next year.

She declined to reveal the scope of the reductions she would seek and said the Government's reform of the sector did not amount to price control.

"Insurance is becoming a huge issue for our society, both for ordinary individuals in terms of their cars and also for employers," she said. "I am determined to ensure it will deliver real change. What's been criticised is the PIAB, which is only one part, one element of the proposal."

On public transport, she said infrastructure remained a priority for the Government. Asked about proposals to build a Metro system in Dublin after the Luas light rail network was completed, she said: "I believe the financial institutions and others, if pursued, will have an interest in investing in these areas."

But Ms Harney would not reveal what funding model might be used in this scenario. "I don't want to go into the technicalities, I just think there's potential there on the transport side ... both on the road side and on the public transport side."

Despite that, informed observers believe revenues on the Metro will be too small to attract large-scale private investment.

Ms Harney projected that an increase in health expenditure would have to be met with delivery of a better service and a significant reduction in waiting lists.

She said: "Initiatives in that area will be important because clearly the manner in which it is delivered at the moment is not delivering the kind of improvements in quality that you would expect with huge increases in expenditure."

While overseas aid increased by €100 million this year to €340 million, it was still €40 million less than agreed. Ms Harney said: "We have given a commitment to reach the UN target of 0.7 per cent by 2007 and the Taoiseach reiterated that recently and I think that should be a priority for the Government."

Ms Harney said she would be very disappointed if there was no new national pay agreement, but acknowledged a pact would be difficult to secure. She said: "If we want to pay ourselves more, we'll have to increase the level of activity in the economy. We have to enhance the skills base to bring more value-added activity here and that's actually what's happening. A lot of the projects that we would have been chasing even five years ago, we wouldn't be chasing now."

But while the negotiation would be "as challenging as it was in the mid-1980s", the Government needed to indicate that there was no crisis in the economy, despite the deficit in the public finances.

She said: "Maintaining employment has to be the number one priority of the social partnership process and therefore we have to focus on innovation and productivity."

But the economy was still "doing very well". "There's a major financial challenge, there's no question about that, but when you're running a current budget surplus of €4 billion and when you have the second-lowest debt in Europe, that's all very healthy."