Fiscal pact agreed by 25 of 27 EU members

European leaders agreed on a permanent rescue fund for the euro zone on Monday and 25 out of 27 EU states backed a German-inspired pact for stricter budget discipline, but they struggled to reconcile fiscal austerity with economic growth. Only Britain and the Czech Republic refused to sign a fiscal compact in March that will impose quasi-automatic sanctions on countries that breach European Union budget deficit limits and pledging to enact balanced budget rules in national law. Officially, the half-day summit focused mainly on a strategy to revive growth and create jobs at a time when governments across Europe are having to cut public spending and raise taxes to tackle mountains of debt. But differences over the limits of austerity, and Greece's unfinished debt restructuring negotiations, hampered efforts to send a more optimistic message that Europe is getting on top of its debt crisis. French President Nicolas Sarkozy told a news conference he expected a final agreement on reducing Greece's debt to private bondholders «in the next few days» and believed that European institutions - a clear reference to the European Central Bank - would decide independently to help meet a funding gap. EU Council President Herman Van Rompuy said a deal was needed this week in order for it to be finalized in time to avert a Greek default in mid-March when it faces huge bond repayments. Asked about a German proposal to place Greek public finances under the control of a European commissar, Sarkozy said: «That there should be supervision is quite normal, but there can be no question of any country being put under stewardship." The leaders agreed that a 500-billion-euro European Stability Mechanism will enter into force in July, a year earlier than planned, to back heavily indebted states. But Europe is already under pressure from the United States, China, the International Monetary Fund and some of its own members to increase the size of the financial firewall. The risk premium on southern European government bonds rose while the euro and stocks fell on concerns about a lack of tangible progress in the Greek debt talks and gloom about Europe's economic outlook.

Highlighting those fears, Spain's economy contracted in the last quarter of 2011 for the first time in two years and looks set to slip into a long recession. France halved its 2012 growth forecast to a mere 0.5 percent in a potentially ominous sign for Sarkozy's troubled bid for re-election in May. The president said Paris could achieve its deficit reduction target without further savings. Conservative Spanish Prime Minister Mariano Rajoy, attending his first EU summit, said Madrid was clearly not going to meet its target of 2.3 percent growth this year. That has raised doubts about whether it can cut its budget deficit from around 8 percent of economic output in 2011 to 4.4 percent by the end of this year as promised. European Commission President Jose Manuel Barroso hinted Brussels may ease Spain's near-unattainable 2012 deficit target after it updates EU growth forecasts on February 23. Italy, rushing through sweeping economic reforms under new Prime Minister Mario Monti, was rewarded with a significant fall in its borrowing costs at an auction of 10- and 5-year bonds, despite two-notch downgrades of its credit rating by Standard & Poor's and Fitch this month. But Portugal's slide towards becoming the next Greece - needing a second bailout to avoid chaotic bankruptcy - gathered pace as banks raised the cost of insuring government bonds against default and insisted the money be paid up front instead of over several years. The yield spread on 10-year Portuguese bonds over safe haven German Bunds topped 15 percentage points for the first time in the euro era. Many economists doubt the wisdom of so severely restricting deficit spending and EU diplomats say the fiscal compact was mostly a political gesture to calm German voters angry at repeated euro zone bailouts and to restore market confidence. European Parliament President Martin Schulz told the leaders the new fiscal treaty was unnecessary and unbalanced, because it failed to combine budget rigor with investment in public works to create jobs. "To write into law a Germanic view of how one should run an economy and that essentially makes Keynesianism illegal is not something we would do,» a British official said. Sarkozy said Czech Prime Minister Petr Necas had said he could not sign up now for constitutional reasons.

There was no repetition of last month's confrontation between British Prime Minister David Cameron and Sarkozy when Cameron vetoed efforts to amend the EU treaty to tighten euro zone budget discipline. But the British leader told reporters: «We are not signing this treaty. We are not ratifying it. And it places no obligations on the UK. "Our national interest is that these countries get on and sort out the mess that is the euro,» he added. German Chancellor Angela Merkel said that although Cameron had shown no sign of relenting in his opposition to treaty change, the new pact could be easily slotted into EU law at a later date and she expected it would be within five years. The 17th summit in two years as the EU battles to resolve its sovereign debt problems was called to shift the narrative away from politically unpopular austerity and towards growth. Merkel said it would not be the last crisis summit, but Monday's meeting had made a «small but fine step on the road to restoring confidence." Negotiations between Greece and private bondholders over restructuring 200 billion euros of debt made progress over the weekend, but were not concluded before the summit. Until there is a deal, EU leaders cannot move forward with a second, 130-billion-euro rescue program for Athens, which they originally pledged at a summit last October.

A Greek official said Prime Minister Lucas Papademos and his finance minister met the heads of EU institutions after the summit to discuss the rescue package. Germany caused outrage in Greece by proposing that Brussels take control of Greek public finances to ensure it meets fiscal targets. Greek Finance Minister Evangelos Venizelos said that to make his country choose between national dignity and financial assistance ignored the lessons of history. Merkel played down the controversy, saying EU leaders had agreed in October that Greece was a special case that required more European help and supervision to implement reforms and achieve its fiscal targets. The ESM was meant to replace the European Financial Stability Facility, a temporary fund that has been used to bail out Ireland and Portugal. But pressure is mounting to combine the resources of the two funds to create a super-firewall of 750 billion euros ($1 trillion). The IMF says if Europe puts up more of its own money, that will convince others to give more resources to the IMF, boosting its crisis-fighting abilities and improving market sentiment. Merkel has said she will not discuss the issue of the ESM/EFSF's ceiling until the next EU summit in March. Meanwhile, financial markets will continue to worry that there may not be sufficient rescue funds available to help the likes of Italy and Spain if they run into renewed debt funding problems.

"There are certainly signals that Germany is willing to consider it and it is rather geared towards March from the German side,» a senior euro zone official said. The leaders announced that up to 20 billion euros of unspent funds from the EU's 2007-2013 budget will be recycled towards job creation, especially among the young, and will commit to freeing up bank lending to small- and medium-sized companies. But with no new public money available for a stimulus, they focused mainly on promoting structural reforms such as loosening labor market regulation, cutting red tape for business and promoting innovation. [Reuters]

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