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Europe Forges Closer Fiscal Ties

Leaders of 25 European Union governments agreed Monday night on what some billed as a historic pact to move to closer fiscal union and signed off on the details of a permanent bailout fund for the euro zone—yet Greece's looming debt restructuring threw a shadow over the summit.
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Reuters

French President Nicolas Sarkozy, left, German Chancellor Angela Merkel, center, and Italy's Prime Minister Mario Monti talked before a meeting in Brussels on Monday.
The leaders discussed Greece but provided no further clarity on the eventual outcome of an issue that was creating increasing nervousness in financial markets Monday.
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European stocks fell Monday and the euro lost ground against the dollar, while Portugal's borrowing costs surged, with the 10-year government bond yield reaching euro-era highs. News of the fiscal pact was announced after markets closed in the U.S.

In a joint summit statement, the leaders noted "tentative signs" of economic stabilization in Europe but said financial-market tensions continue to weigh on the economy.
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The final shape of the deal to reduce Greece's debt is still unknown after months of wrangling between the Greek government, representatives of bondholders, and officials from the EU, the International Monetary Fund and the European Central Bank.
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After Monday's meeting, senior officials said they expected a debt-restructuring accord in "coming days," in time to launch a bond-exchange offer to private investors by mid-February.

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Greek Debt Deal May Not Equal Wall Street Relief Access thousands of business sources not available on the free web. Learn More After the summit, Greek Prime Minister Lucas Papademos met with other senior European officials, including J?rg Asmussen, the German representative on the board of the European Central Bank. Officials said the talks likely concerned conditions to be imposed on Greece so it can receive its new loans.
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Even if an agreement is reached to cut the face value of Greek bonds in private hands by half, Greece is still likely to need close to €150 billion of new bailout funding from other euro-zone governments and the IMF.One question the summit didn't address: whether official creditors, such as the ECB, will also be needed to reduce Greece's debt to levels that it is likely to be able to sustain in the long term.

The uncertainty about the debt agreement—and whether it will be forced on unwilling bondholders—is raising questions particularly about Portugal, whose €78 billion bailout agreed last year is now looking inadequate to some investors.
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Yields on two-year Portuguese bonds rose over 21%, indicating investors see a significant risk of default. Portugal Prime Minister Pedro Passos Coelho said holders of Portuguese bonds will never face the writeoffs that will be suffered by investors in Greece. "Portugal's debt is perfectly sustainable," he said after the meeting.

The fiscal pact agreed Monday is a German-sponsored treaty among the 17 euro-zone nations and eight other EU countries that imposes tighter budget discipline on members and is aimed to prevent a repeat of the Greek debt disaster. Britain and the Czech Republic are the only two EU countries not to join.

"Considering the time frame, this was a real masterpiece," German Chancellor Angela Merkel said. The pact was first mooted in December.

While the euro members share a central bank and monetary policy, absence of strong budget coordination has been one of the weaknesses that led to the crisis.

The leaders agreed that the European Court of Justice will be empowered to impose fines on countries running excessive deficits. The fines will be capped at 0.1% of gross domestic product. For Italy, for example, that could mean fines as high as $2 billion.

It will require governments to keep their budget deficits to an average of 0.5% of GDP over the economic cycle—and to reduce their total government debt toward 60% of GDP over time.

The EU has long-standing rules that are supposed to limit budget deficits in any year to 3% of GDP, and limiting government debt to 60% of GDP, but they have never been enforced.

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