FAQ on Europe's 'fiscal compact'

All European Union states except Britain moved toward setting up a new treaty Friday, giving up crucial powers over their own budgets in an attempt to overcome a crippling debt crisis.
France's President Nicolas Sarkozy greets German Chancellor Angela Merkel earlier this month. All European Union states except Britain moved toward setting up a new treaty Friday, giving up crucial powers over their own budgets in an attempt to overcome a crippling debt crisis. (Charles Platiau/Reuters)

All European Union states except Britain agreed to set up a new "fiscal compact" Friday that will require them to give up crucial powers over their own budgets in an attempt to overcome a crippling debt crisis.

The aim of two days of high-level talks in Brussels had been to amend the existing treaties that govern the EU, mainly the Lisbon Treaty, to include strong fiscal reforms, but without Britain's participation, that was not possible so a new intergovernmental treaty will have to be signed among the member countries that agree to it and will not be an EU-wide treaty.

The new fiscal provisions would not have applied to Britain anyway, since it, along with Denmark, has opted out of the eurozone, but it had wanted to use the opportunity to secure protections from other EU regulations that might encroach on its financial sector.

The bulk of provisions in the new treaty are geared at stabilizing Europe's finances in the long-term and will not address the current debt crisis per se.

Who's in it?

All 17 countries that use the euro have definitely agreed to the new rules. Nine non-euro states — Denmark, Latvia, Lithuania, Poland, Romania, Bulgaria, Hungary, Sweden and the Czech Republic — said they would consult their parliaments before agreeing to the new treaty. In some of those countries, however, parliaments are less than enthusiastic.

The non-euro countries would not be subject to the new rules until they actually adopted the euro. Except for the U.K. and Denmark, which have opted out of the euro, any country that enters the European Union commits to adopting the euro once it meets all the requirements for entry into the eurozone.

Who's not in it?

The U.K. soundly rejected the proposed deal after it failed to get the eurozone to approve special safeguards that would protect its financial centre from EU regulation.

Why did Europe need a new treaty?

For the past two years, the countries that use the euro have been rocked by a debt crisis that has recently threatened the survival of the currency. Germany and France, in particular, argued that only tough rules enshrined in a treaty would convince markets that all countries will be able to repay their debts and a similar crisis will never happen again.

The eurozone countries already have restrictions on their budget deficits and national debt which are set out in a series of eurozone rules known as the Maastricht criteria, but some countries have complained the enforcement of those criteria has not been rigorous enough and that countries that have exceeded the debt ceiling have not been penalized.

What did they agree to?

  • The new fiscal compact obliges eurozone countries to incorporate a balanced budget provision into their national constitutions, committing them to keeping annual structural deficits at or below 0.5 per cent of nominal GDP. The provision must also include an automatic correction mechanism that kicks in if the deficits exceeds the ceiling.
  • The Court of Justice of the European Union, which is in charge of ensuring that state laws are in line with EU regulations, will be in charge of ensuring legislation adopted on a national-level complies with the treaty.
  • That budget cap can be broken to counteract a recession or in other exceptional circumstances.
  • Automatic penalties, including fines, will kick in if signatories exceed deficit limits unless a qualified majority of eurozone states opposes such penalties. Currently, the eurozone already has a so-called excessive deficit procedure that is supposed to kick in once a country exceeds the three per cent of GDP cap on national budget deficits set out in the Maastricht criteria. But in the past, the procedure has not been enforced as rigorously as it should be since governments often allied with partner states and used their majority to reinterpret the rules and avoid fines and other sanctions.
  • All states have to tell the other signatories to the treaty in advance how much debt they plan to take on through bond sales.

What else did they decide?

  • The eurozone, together with other willing EU states, will give as much as 200 billion euros to the International Monetary Fund in the form of bilateral loans so that it has adequate resources to help financially troubled nations.
  • The eurozone's new permanent bailout fund, the European Stability Mechanism, will take over from the current rescue fund, the European Financial Stability Facility, one year ahead of schedule, in July 2012. Unlike the EFSF, the ESM has paid-in capital, similar to a bank, and is therefore more credible on financial markets.
  • The ESM's decision-making process was simplified in emergency situations, allowing struggling countries to get financial help if an 85 per cent majority of capital holders agree. That is meant to stop small countries from blocking or slowing down urgent rescues, as has happened in the past.
  • The eurozone eased rules that have forced banks and other private investors to take losses when a country gets a bailout from the ESM. The previous push to inflict losses on bondholders has been blamed for exacerbating the crisis.

What did they fail to agree on?

  • Eurozone leaders did not decide to boost the overall firepower of their own bailout funds, which is currently limited to 500 billion euros although they did agree to accelerate capital payments and to reconsider the cap in March. They also rejected the proposal to run the two rescue funds — the European Stability Mechanism and the European Financial Stability Facility — simultaneously.
  • They did not agree to more intrusive powers for the European Commission over the fiscal policies of wayward states, as had been demanded by European Council President Herman Van Rompuy and some nations. Instead, they promised to "examine swiftly" much more lenient proposals from the Commission.
  • They did not allow the bailout funds to directly recapitalize failing banks. That could have prevented countries from taking on more debt when they have to bail out lenders.

Will it work?

Stock markets and the euro rose modestly in reaction to the deal, but many details remain to be worked out, including how the treaty will be enforced. Since the fiscal compact is not an EU treaty, the European Commission, which is the body usually charged with enforcing EU regulations and policies, won't be able to enforce it, and no new enforcement body has been specified.

Words of approval from European Central Bank president Mario Draghi boosted confidence in the deal.

"It’s going to be the basis for a good fiscal compact and more discipline in economic policy in the euro area members," Draghi said of the new treaty.

Much, however, will depend on whether the stricter fiscal rules can persuade the ECB to unleash massive funds to buy up bad eurozone debt.