EU debates new debt rules as euro surges

European finance ministers will attempt to draw up stricter budget rules to avoid another government debt crisis, as the surging euro cast doubt on the continent’s fragile economic recovery.

Two differing proposals spelling out penalties for overspending governments will be considered today, after ballooning debt and deficit levels in countries like Greece, Ireland and Spain shook the foundations of the 16-nation eurozone earlier this year.

The two-day gathering in Luxembourg comes amid the spectre of a possible global currency war as governments around the world try to boost their economies by pushing down the value of their currencies, thus making their exports more competitive.

The US Federal Reserve spurred expectations of a new round of asset purchases on Friday, in effect pumping dollars into the economy and further weakening the value of the greenback. The euro jumped to $1.41 on Friday, from under $1.29 in early September.

Yet the European Central Bank, which sets monetary policy for the 16 countries that use the euro, appears likely to remain on the sidelines in any currency war.

Top EU officials, including ECB bank president Jean-Claude Trichet, have complained about China – a major trade partner – intervening to keep its currency weak.

But the eurozone appears unlikely to take action beyond talk and diplomacy. In fact, several ECB officials in the past week have pushed for a quicker unwinding of the bank’s crisis-relief measures, such as its government bond purchasing programme.

Such a hands-off policy by the ECB could mean trouble for the currency union’s weakest members, facing harsh government budget cuts and desperate for export-led growth.

“The eurozone is likely to be the loser in this,” said Simon Tilford, chief economist at the Centre for European Reform in London. He said big Asian economies like China and South Korea would race to keep their own currencies stable against the dollar.

In an environment of competitive currency devaluation “the eurozone exporting its way out of this is not going to happen”, he said.

That means there is all the more pressure for European finance ministers to come up with effective rules that keep public spending in check without endangering economic growth. But governments remain divided over proposals announced by the European Commission, the EU’s executive arm, last month.

A second set of rules is being drawn up by a group led by EU president Herman Van Rompuy. This task force, which includes Mr Trichet, EU monetary affairs chief Olli Rehn and the eurozone finance ministers, will meet for one last time today before presenting its report to EU governments at the end of the month.

The commission wants to force member states whose deficit tops 3% or whose debt hits 60% of gross domestic product to set aside up to 0.2% of their GDP. If governments fail to follow the commission’s recommendations, these deposits could be converted into fines.

These penalties would be imposed automatically, unless they are overruled by a qualified majority of finance ministers – an approach backed by Germany. Other countries, led by France, are very reluctant to hand over that much power to unelected officials in Brussels.

More divisions remain over potential sanctions for countries that fail to address other issues, such a property and lending bubbles or uncompetitive wages - macroeconomic imbalances that many economists say were at the heart of Europe’s government debt crisis.

The EU finance ministers will also prepare their position for a meeting with their counterparts in the Group of 20 rich and developing nations beginning on Friday in Seoul, South Korea.

The currencies question is sure to dominate that agenda after recent talks at the International Monetary Fund in Washington failed to produce an agreement.

European leaders will also have to decide whether they are prepared give up seats on the IMF’s decision-making board to give developing countries more say, as the US has demanded.

Another possible issue in Luxembourg could be new regulation for hedge funds. Officials said they were nearing a compromise on a so-called European passport, that would allow non-EU-based hedge funds and fund managers access to the entire European market.

The EU is keen to have these hedge-fund rules drawn up before they head to Seoul, where leaders will discuss new global financial regulation.

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