Europe debates on avoiding another debt crisis

New York: European officials are jostling over plans to tighten the region's fiscal rules to ward off another sovereign debt crisis, but agreement on anything that could be enforced by meaningful sanctions is far from certain.

At the same time, some observers are arguing that any changes might be a sideshow and that the real means of avoiding problems in the future lies in the discipline imposed by investors who are asked to finance government debts -- a fundamental rethinking of the way the euro works.

With the decade-old euro project nearly brought down this year by the profligacy of Greece, pressure is again building -- notably from German and French leaders -- to enact rule modifications that bring about real changes in behavior.

How times have changed. Back in 2003, the rules were effectively cast aside when France and Germany persuaded their partners to block planned sanctions against them for exceeding the fiscal deficit ceiling. Since then, the rules have been more loosely interpreted even as the number of countries breaching them has exploded.

According to Eurostat, the latest data from 2009 shows that of the 27 members of the European Union, only Denmark, Estonia, Luxembourg, Sweden and Finland had deficits below the pact's limit of 3 percent of gross domestic product.

Now, because of the political crisis over the Greek bailout, there are many views on how tough the new rules should be, and even who should be in charge of rewriting them.

The European Commission, which alone has the formal power to propose changes, is working on one set. So is a committee drawn from the bloc's 27 member states, which have to sign off on them -- not to mention foot any bill.

It is unclear how the two sets of proposals will be reconciled. The issue has the potential to escalate into a long and ugly institutional tussle, further undermining the euro's stability.

Indeed, the debate over the budget rules goes to the heart of the success or failure of the euro project.

The sovereign debt crisis showed the inherent problems of running a currency union without central fiscal authority. Yet sovereign countries are reluctant to hand over politically tricky tax and spending policy to an unelected committee.

In a speech last week, the managing director of the International Monetary Fund, Dominique Strauss-Kahn, made clear his preference for a "centralized fiscal authority, with political independence," comparable to that of the European Central Bank. Strauss-Kahn conceded, though, that the chances of national governments ceding control over their budgets "appears unlikely in the foreseeable future."

Undeterred, the European Commission is preparing to present its ideas soon. These are likely to add a country's ratio of debt to gross domestic product as a criterion that could lead to sanctions, rather than just deficit ratios, as is the case now.

Under the current rules, euro one countries can eventually be fined up to 0.5 percent of their GDP each year if it is agreed to by a majority of ministers. Such a fine has never been imposed.

One alternative being discussed would be to withhold so-called structural and cohesion funds, which are allocated by Brussels primarily to the bloc's poorer nations. Strauss-Kahn also suggested that fines could be "smoothed" over time by trimming such transfers.

But political and legal objections to more complex sanctions have been raised -- not least because they could push economically weak nations into deeper trouble. In March, Chancellor Angela Merkel of Germany described the idea of fining countries in financial trouble as "idiotic."

There also has been a suggestion of suspending political voting rights for countries that breach budget limits.

Paris and Berlin sent a letter to Herman Van Rompuy, president of the European Council, in July backing the idea of withdrawing voting rights within the union from budget offenders.

But officials worry about the political fallout and whether Paris or Berlin would be willing to apply the sanction to themselves.

Because of the difficulty of achieving consensus, the governmental committee, led by Van Rompuy, is now focusing on securing an agreement among the nations that use the euro, an easier task than reaching consensus among all 27 nations of the European Union. But even here there are complications.

One involves how to calculate the level of debt. Several of the union's newer member states argue that pension obligations must be considered when calculating debt levels. Italy is pressing for private as well as public debt to be taken into account.

The debate is delicate because several nations have debt levels greater than 60 percent of GDP, the original ceiling set out for membership of the euro. That means that any future sanctions could apply widely.

Van Rompuy's group will meet again at the start of next week. It aims to present initial findings to leaders at a summit at the end of October. Van Rompuy may seek to extend the group's mandate to discuss measures that would involve a change to the European Union treaty.

This would require agreement of all 27 nations and might involve time-consuming and politically risky referendums in some. For that reason, most nations oppose the idea.

So officials are now focusing on working within the existing rule book, arguing that the union's new Lisbon Treaty allows them sufficient leeway.

Sixten Korkman, director of the Research Institute of the Finnish Economy, said treaty changes were unlikely, given their legal and political complexity.

But he said certain rule changes within the current framework could be effective -- notably, improving the independence of fiscal policy in certain weak members, particularly Greece. He also backed some kind of mechanism to restructure ballooning debts through discounts on bond holdings, whereby investors also pay a price; and establishing a means for the European Central Bank to make it more expensive for countries with weak finances to get access to funds.

David Clark, a former adviser to the British government on European affairs, said tinkering with the current rules would only prolong the "inherent instability" of the economic and monetary union.

He said a fundamental problem needed to be addressed, formally or informally - how to "rebalance" the euro zone's structure. Currently, he argued, Germany's export-oriented economy is accruing the benefits, while poorer neighbors are being forced to retrench.

Mr. Korkman added, "What is most important is the behavior of investors and politicians. I think and hope that this crisis has been a steep learning curve for both."