Feb. 10 (Bloomberg) -- European Union regulators threatened to outlaw a French plan linking loans to carmakers with the companies’ vows to keep domestic production as governments in the 27-nation bloc said the measures hurt competition.

PSA Peugeot Citroen and Renault SA will each get 3 billion euros ($3.9 billion) in loans from the French government after promising to preserve jobs and production in the country. The European Commission, which polices whether government aid distorts competition, said the conditions may break EU rules.

“There are indications that carmakers will be obliged to maintain their center of production in France as a condition for government support,” Jonathan Todd, a spokesman for the commission, told journalists today in Brussels. “The commission will not authorize aid that would tend to undermine the single market.”

French President Nicolas Sarkozy is trying to save jobs in Europe’s third-largest economy, where unemployment has reached a two-year high as the country enters its first recession in 16 years. Production of cars and parts in France fell 39 percent in the fourth quarter from a year earlier, a government report showed today, as carmakers as well as their suppliers shut some factories temporarily to counter the slump.

French Finance Minister Christine Lagarde said yesterday in Brussels that the plan isn’t protectionist. Bruno Silvestre, her spokesman, declined to comment on what the commission said today.

Letter to France

Todd said the commission wrote a letter to France asking for more details on the car industry support plan. Under EU single market rules, companies can set up businesses, invest and sell products anywhere in the region. Governments aren’t allowed to favor national companies when granting tax breaks, soft loans at reduced rates of interest, or other incentives.

Any conditions that violate these rules “would render the aid illegal and will not be tolerated by the commission,” Todd said. “If there are measures that question the single market, the risk would be that the recession would be much worse, even becoming a depression as in the 1930s.”

Under the French plan, Peugeot and Renault will each get a five-year loan at a 6 percent rate from the government. Renault Trucks, which is owned by Volvo AB of Sweden, and some other automakers will also receive 500 million euros in loans.

The commission’s warning to France comes as Sweden, the Czech Republic and Slovakia criticized the French plan, saying that it will hurt competition.

‘Problematic for Sweden’

“It is of course problematic for Sweden,” Anders Borg, the country’s finance minister, said today in Brussels, where he is attending monthly meeting of EU finance chiefs. “We try to deal with it in a fair way that is also strengthening competition, and I think everybody should do that.”

French carmakers have moved production to Eastern Europe to benefit from lower wages and cheaper production costs. Paris- based Peugeot, Europe’s second-largest carmaker, began making small cars in the Czech Republic in 2005 at a factory jointly owned with Toyota Motor Corp.

Sarkozy said in a broadcast interview on Feb. 5. that making cars in the Czech Republic and selling them in France “isn’t justified.” “I want to stop relocation abroad” and return jobs to France “if possible,” he said.

Czech Prime Minister Mirek Topolanek said on Feb. 6 that Sarkozy’s statements go against the EU’s free-market and competition principles. The Czech Republic, which joined the EU in 2004, has attracted investments from carmakers such as Volkswagen AG’s Skoda Auto AS and Hyundai Motor Co. The country assumed the EU presidency on Jan. 1 from France.

‘Totally Against’

Slovak Finance Minister Jan Pociatek said today his country is “totally against” the French proposal. “The philosophy of the EU is a single market without any barriers to transfer products and services,” he told reporters today during the EU finance ministers’ meeting in Brussels.

Germany’s VDA auto-industry association said the French measures are a “a clear distortion of competition,” according to daily newspaper Handelsblatt, in an article published today.

“We don’t want an international race in subsidies,” Handelsblatt cited VDA executive director Klaus Braeunig as saying.

To contact the reporters on this story: Matthew Newman in Brussels at Mnewman6@bloomberg.net; Francois de Beaupuy in Brussels at fdebeaupuy@bloomberg.net.

Last Updated: February 10, 2009 12:50 EST