By Emma Charlton

BRUSSELS (MNI) – A political deal finalised late Monday moves
Europe one step closer to stricter fiscal surveillance, but several key
issues remain to be settled.

“The devil will be in the details,” Jean-Claude Juncker,
Luxembourg’s Prime Minister and president of the Eurogroup, told
reporters late Monday, thus making clear that in fact the deal is not
yet sealed.

The agreement, brokered by European Council President Herman Van
Rompuy, would impose earlier fines and sanctions for fiscal rule
breakers, and it would create a permanent crisis mechanism to rescue
Eurozone members that fall into financial difficulty. It would also
establish debt-cutting targets for the first time, thus giving the same
weight to debt loads as to deficits.

The new regime, if approved by EU leaders, would come into force by
2012. The strictest of the new rules would apply to the Eurozone
countries first, with a view to extending them to all 27 EU countries,
except the UK, at a later stage.

Still to be determined is the degree of Treaty change that will be
required to implement the rules; the amount of the fines; the rate of
debt reduction that will be required; and the macroeconomic indicators
to be monitored.

“It was a long and arduous negotiation yesterday and I think we
have now got a result and a final report which respects the level of
ambition,” a diplomat close to Van Rompuy said. But this official
conceded that more work was needed on the technical aspects.

The proposals could run into difficulty when they are debated at a
summit of EU leaders on October 28 and 29. While France and Germany have
joined forces to back a change to the EU treaty, other countries,
including the UK and Sweden, strongly oppose this idea.

DEBT LEVELS TAKE NEW ROLE

Current EU rules stipulate that countries must keep their annual
budget deficits below 3% of GDP and their debt levels below 60%.
Currently 15 out of the 16 euro-sharing states are in breach of the debt
limit, with only Luxembourg below the 60% threshold.

Under the new rules, an excessive debt procedure (EDP) would be
triggered if the debt levels rose above the 60% threshold. What hasn’t
yet been agreed on is the rate of debt reduction that would be required.

Under the European Commission’s proposal, countries above the debt
ceiling would be required to reduce their debt stock by 5% of the
outstanding total each year.

Van Rompuy’s report – which the heads of state and government will
examine next week – doesn’t contain a specific number. It merely says
that there must be a “clearly quantitative” criterion,” according to an
EU diplomat. The choice is essentially between the Commission’s proposal
and keeping the current system, but with numerical criteria added, the
diplomat said.

Several member states are said to favour the second approach,
because having a medium-term objective gives more leeway than the
Commission’s requirement for an absolute reduction each year.

SEMI-AUTOMATIC SANCTIONS

The deal spells out two rounds of possible economic sanctions: one
in the preventive phase, before a country breaches either the debt or
deficit limits, and a second in the corrective phase, after the country
has breached the rules and is in the excessive deficit or debt
procedure.

This would be the first time that an EU member could be penalized
before it actually breached the fiscal rules. “Even before you reach a
deficit of 3%, if [the Commission and the EU Council] see that your
deficit is not on a downward path, but is on an upward path…you can
receive a warning. You get 6 months to put yourself in order, and if you
don’t you will be hit by sanctions,” the EU diplomat said.

The sanctions initially would take the form of a deposit, which
pays interest to the country required to make it. However, if the
country fails to comply with the Commission’s directive within six
months, the deposit stops paying interest. And if another six months
pass without action, it becomes a fine and the country no longer gets it
back.

“We want to act upstream, before the accidents happen,” the
diplomat said.

Decisions to place these sanctions are made by reverse majority —
ie, a qualified majority of votes would be required to remove the
penalties but not to impose them in the first place.

“It’s not entirely automatic, but there is a high degree of
automaticity” the diplomat said.

In the corrective phase, the sanctions operate much in the same
way: a interest-bearing deposit is taken, which after six-months of
insufficient action becomes a non-interest bearing deposit and then
after a second six-months, is retained as a fine.

If the country had already been warned in the preventive phase,
then the corrective phase is speedier, with the deposit bearing no
interest and then converting to a fine.

The amounts of these fines are still open to debate.

The European Commission proposals suggest 0.2% of GDP, but EU
sources said the level is not mentioned in the report that will be
delivered to heads of state and government next week.

“That will be an issue to be dealt with during the legislative
process,” the EU diplomat said. But he added: “I didn’t hear many
objections to the level that the Commission has been proposing. We may
see other ideas or resistance appear in the legislative phase, but there
was not an outcry at the table yesterday.”

MACRO-ECONOMIC INDICATORS

In a bid to up competitiveness among the countries, the Commission
has proposed a new macroeconomic surveillance board and wants to be able
to send inspectors to countries to make reports on remedial actions that
need to be taken.

The diplomat said that the Commission hoped the publication of such
reports would be made public, and would shame the country in question
into action for fear of damage to its reputation.

“If a country does not listen to the report’s recommendations,
financial sanctions will kick in,” he said.

There is broad agreement on this part of the deal — except for the
actual indicators that the Commission would be able to monitor.

“The precise indicators will have to be elaborated in the
legislative phase,” an EU diplomat said. “The exact configuration of the
economic indicators isn’t yet known.”

CONTROVERSIAL TREATY CHANGE

One of the most controversial parts of the deal is the potential
need for changing the underlying EU legislation set out in the treaties
of Maastricht and Lisbon.

Any treaty change has to be unanimously agreed by all 27 states
that make up the European Union.

On Monday, France and Germany backed a treaty change, saying it was
the best way to create a permanent crisis mechanism for the Eurozone.

Currently there are two make-shift Eurozone emergency financing
mechanisms, both of which expire in 2013: a E110 billion aid deal for
Greece and a separate E440 billion European Financial Stability
Mechanism which any troubled Eurozone member could tap.

“It was decided yesterday that ‘yes’ there is a need for having a
crisis mechanism for the Eurozone,” the diplomat said.

He said more technical work was needed on the conditionality that
would be attached to such a mechanism, on the concept of allowing for no
moral hazard in the plans, and on the role played by the International
Monetary Fund.

He said opening up the treaty for change, although controversial,
would also allow for other parts of the new rules to be enshrined,
grounding the new discipline firmly in the legislation.

Now that France and Germany have backed the idea of changing the
treaty, they will have to convince the other 25 EU members, many of whom
are extremely skeptical that treaty change is the best way forward.

“Changing treaties is not an easy job at all, it involves some
complex procedures and it would also require unanimity at the EU level,”
the EU diplomat said.

–Brussels: 0032 487 (0) 32 803 665, echarlton@marketnews.com

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