Q&A: EU fiscal treaty to control eurozone budgets

Germany's Chancellor Angela Merkel and French President Nicolas Sarkozy, 5 Dec 11 France and Germany led the drive for much closer eurozone co-ordination

Twenty-five of the EU's 27 member states have signed a landmark treaty to co-ordinate their budget policies and impose penalties on rule-breakers - the "fiscal compact".

The Czech Republic and the UK opted out of the legally binding treaty.

In December EU leaders, desperate to avoid a re-run of the 2007-2008 credit crunch, sought an accord involving all 27 states - the 17 in the euro and 10 outside the euro.

But after lengthy talks a UK veto meant that the others agreed to a separate eurozone pact. It is called a "treaty" but under EU law it is an inter-governmental agreement, not yet written into the EU treaties.

What does this treaty mean for the EU?

It is aimed at restoring confidence in the euro. To do that, EU governments - including the UK - agree that much closer budget co-ordination is needed in the eurozone.

The UK will not be bound by the pact, but it has been an observer at the negotiations on it.

Since this is not a full-blown EU-wide treaty it should be possible to adopt it quickly, without time-consuming debates in national parliaments or referendums.

The plan is for it to enter into force on 1 January next year, if at least 12 eurozone countries have ratified it.

The key points are:

  • A "balanced budget rule" to be incorporated into national legal systems, at constitutional level or equivalent;
  • European Court of Justice to check whether nations implement budget rule properly - it will fine them up to 0.1% of national output (GDP) if they fail to do so;
  • More automatic mechanism to force states to correct budget deficits - it will kick in unless a qualified majority of eurozone states vote against it;
  • Plans for bond sales and all major economic reforms to be reported to EU institutions in advance;
  • Eurozone summits to be held at least twice a year;
  • Treaty to be signed in March and remain open to other EU countries that wish to join;
  • Aim is to incorporate it into EU treaties within five years of it taking effect.
Why did the UK refuse to sign up?

UK Prime Minister David Cameron objected to proposals for financial service regulations that would affect the City of London. He also said there were insufficient safeguards for the future workings of the EU single market. After he was denied an opt-out, he rejected the deal.

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The use of EU institutions to police the new treaty is also controversial for the UK government.

In December Mr Cameron said the European Court of Justice and the European Commission could only carry out policies applying to all 27 EU states.

Now he says he will not block the use of EU institutions in the new mechanism, even though he has "legal concerns". He promised to watch the treaty's development "like a hawk".

Mr Cameron told MPs in Westminster that the treaty "does not have the force of EU law for us, nor for EU institutions... that protection remains".

Some prominent politicians in his own party have questioned his position on the new treaty, voicing fears that the UK opt-out may be undermined.

Opposition Labour Party leader Ed Miliband mocked Mr Cameron's veto, saying he had "secured absolutely no protections at all" for the UK.

Why did the Czechs join the UK in opting out?

Czech Prime Minister Petr Necas said questions over some of the treaty's text and uncertainty over its ratification at home had prevented him from committing to it. But he did not rule out that the Czechs could sign up to it later.

The Czech Republic is not yet in the euro and has not set a date for joining.

Czech President Vaclav Klaus, a Eurosceptic, does not want to sign the new treaty. But he will step down in March next year, so he may not be a block to Czech ratification.

Are we seeing a two-tier or two-speed Europe taking shape?

Having wielded the UK's veto Mr Cameron has spoken of a multi-speed EU.

Eurozone countries

  • Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, Spain

French President Nicolas Sarkozy has also openly talked about a two-speed Europe emerging, but other EU leaders have played down the idea.

Mr Sarkozy was referring to further enlargement of the EU. The next countries to join would need time to catch up, so they would be less integrated than the eurozone, he suggested.

Even before the new pact was sealed the eurozone had agreed to hold separate summits, in addition to the summits of all 27. A two-tier or two-speed Europe now looks more likely than ever.

Only the UK and Denmark have clear opt-outs from the euro. The other eight member states not yet in the euro are treaty-bound to adopt it.

In practice countries in the EU already move at different speeds, on many different issues.

But in the huge area of budget policy - including co-ordination on taxes - the UK could eventually end up isolated in the EU. And that could lead to numerous legal challenges.

Why are EU summits these days called make-or-break for the eurozone?

The credibility of the euro is at stake. There have been plenty of "crunch" EU summits in the past two years focused on tackling the debt crisis plaguing Europe. Yet the crisis has deepened, threatening to turn economic malaise into a general recession.

There are no quick fixes for the underlying problem - the fact that the currency union, launched in 1999, lashed together countries with very different economies.

The rules for keeping balanced budgets were broken, creating instability. Investors lost confidence in the value of some countries' debt, traded as sovereign bonds.

When Greece, Ireland and Portugal could no longer afford the interest rates charged by lenders they had to be bailed out by the EU and International Monetary Fund to prevent default.

Why did France and Germany want EU treaty changes?

Franco-German package

  • Automatic sanctions for any country which runs up a deficit of more than 3% of GDP
  • "Golden rule" built into eurozone members' budgets against running a deficit
  • Private investors never again to be asked to take losses, as in Greece
  • European Stability Mechanism (ESM) brought forward from 2013 to 2012, with decisions based on a qualified majority not unanimity
  • Eurozone leaders to meet every month as long as crisis continues to discuss growth

Germany's Chancellor Angela Merkel said the only way to prevent such a crisis happening again was to enshrine the budget rules in EU treaties. That way there would be a mechanism in primary EU law to impose stiff penalties on countries that overshot the agreed deficit limits.

Mrs Merkel wants other eurozone countries to copy Germany's budget discipline, so that their borrowing is kept under control. France's President Nicolas Sarkozy has echoed her.

Germany and Spain have written budget prudence into their constitutions, and now there is pressure to extend that to all the eurozone countries.

Another key issue is the role of the European Central Bank.

Many politicians and analysts say the ECB ought to act as a lender of last resort - a bigger remit than was envisaged when the euro was launched.

In December the ECB acted to ease the crisis by providing nearly 500bn euros in three-year loans to eurozone banks on generous terms.

The ECB provided 530bn euros in another injection of liquidity on 29 February this year.

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