EU Wields Fines to Save Euro From Greek-Style Fiscal Mishaps

Euro countries would face financial penalties for overstepping budgetary limits or for running non- competitive economies under proposals to prevent an escalation of the debt crisis.

Users of the 16-nation currency would be fined as much as 0.2 percent of gross domestic product for flouting fiscal targets and as much as 0.1 percent of GDP for failing to keep up with Europe’s strongest economies, under draft legislation unveiled today in Brussels.

Building on existing sanctions that were never imposed, the European Commission proposals in response to the Greece-led debt shock lean toward German Chancellor Angela Merkel in her effort to tighten the fiscal screws on free-spending governments and have already fueled qualms in France.

“We will pull the handbrake before the car rolls down the hill,” Jose Barroso, the commission’s president, told reporters.

As more than 100,000 demonstrators converged on Brussels to protest Europe-wide austerity measures, the commission, the European Union’s executive, billed the crackdown on deficit spending as “the most comprehensive reinforcement of economic governance” since the euro’s debut in 1999.

With soaring bond yields in Ireland and Portugal looming as the euro’s next threat, the proposals are meant to fix an economic-management system that failed to prevent Greece from skidding toward default, forcing European governments to offer 860 billion euros ($1.2 trillion) in loans and pledges in May to keep the currency union intact.

Euro’s Rebound

The euro has rallied after reaching a four-year low of $1.1876 on June 7. It traded at $1.3591 at 5 p.m. Brussels time. The euro is 17 percent overvalued, according to a Bloomberg index of the relative buying power of world currencies.

The new system toughens and speeds up a series of fines on governments that head over the euro deficit limit of 3 percent of GDP and debt limit of 60 percent.

Penalties starting with interest-bearing deposits could be imposed before a country bursts over the limit, with the money confiscated if it balks at repeated EU demands to fix the budget. For Greece, which snuck into the euro region without ever meeting the deficit standard and obtained 110 billion euros of the rescue funds, the fine would go as high as 475 million euros.

Debt Penalties

Countries over the debt limit would be ordered to hit an annual reduction target equal to 1/20th of the excess. A country with debt at 100 percent, for example, would need to cut it by 2 percentage points each year.

Initially, the penalties will be limited to countries using the euro. The commission is working on plans to draft rules as of 2014 to non-euro countries such as the U.K., foreseeing cuts in EU subsidies for their fiscal overruns.

Alessandro Leipold, a former International Monetary Fund official, said the emphasis on Brussels-driven sanctions is misguided and urged the EU to do more to embed sound budget practices at the national level.

“If the most severe crisis since the Great Depression and a euro country having to turn the IMF doesn’t focus the minds for something a bit more ambitious, then one has to wonder what will,” said Leipold, who advises the Brussels-based Lisbon Council think tank.

The six-law package requires approval by European governments and the European Parliament. The commission hopes it will take effect by mid-2011, with the first sanctions possible in 2012.

Vote Wrangling

France is among three or four countries that oppose plans for the commission to lay down the sanctions automatically unless blocked by a “qualified majority” in which bigger countries have more votes, an EU official told reporters yesterday.

French Finance Minister Christine Lagarde on Sept. 27 urged a simpler one-country, one-vote system that would lessen the influence of Germany, the country pushing hardest for tougher rules.

France put out its 2011 budget outline today, pledging to shrink the deficit to 6 percent of GDP from an estimated 7.7 percent this year, the fifth-highest in the euro region.

Germany played down the conflict over the voting system. In an interview in Berlin yesterday, Deputy Finance Minister Steffen Kampeter said that “sometimes Germany and France start from different starting points, but we in the end are on common ground.”

Competition Concerns

Beyond stiffening existing rules, the EU’s main innovation is to extend the threat of sanctions to countries prone to “excessive” macroeconomic imbalances such as outsized current account deficits, rapid wage growth or runaway property prices.

Those penalties would be imposed “asymmetrically” on underperforming economies such as Portugal or Greece, while exempting Germany, with its trade surpluses, a senior commission official said yesterday.

While the commission would base its verdict on indicators such as current account, unit labor costs, public and private debt and estimates of real exchange rates, it said there is no “mechanical way” to judge competitiveness.

Sony Kapoor, managing director of Re-Define, an economic research institute, said the competitiveness standards will be impossible to enforce because governments have limited power over the behavior of millions of producers, consumers and investors.

“The approach assumes levels of government control over economic outcomes that probably did not even exist in the Soviet Union, let alone modern market economies,” Kapoor said. “The policy space available to governments in the euro zone to influence economic outcomes is especially limited.”

To contact the reporter on this story: James G. Neuger in Brussels at jneuger@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net

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