EU struggles to prevent new debt crisis

The European Union is finally closing in on new oversight rules to ensure sound finances, prevent another government debt crisis and restore the credibility of the euro.

But even after months of agonising, leaders remain divided on key issues and some analysts argue that even the latest proposals cannot fix the bloc’s fundamental problems.

EU finance ministers will try to sort out two different proposals for stricter rules to back up the euro when they meet on Monday and Tuesday in Luxembourg, hoping for a decision at a summit by heads of state and government on October 28 and 29.

The proposals spell out sanctions for countries who run up deficits and debts that are too big – overspending that could undermine the shared euro currency, as Greece did when it almost went bankrupt in May and had to be bailed out by eurozone governments and the International Monetary Fund.

A key thorny question will be whether the European Commission, the EU’s executive arm, will get greater powers to monitor troubling developments in individual countries’ economies – such as trade imbalances or property bubbles - and to fine countries that do not follow its recommendations.

In its proposals announced last month, the commission gave itself exactly those powers.

Many economists argue that private debt levels and inflated wages, rather than government debt and deficits, were the main culprits behind the crises in some countries with troubled government finances such as Ireland and Spain.

At the end of 2007, for instance, Ireland’s debts stood at only about 25% of gross domestic product – well below the EU’s 60% ceiling – but labour costs and house prices had jumped in the past decade.

When the crisis hit and economies shrunk, banks were left with mortgages and debts that could not be repaid by people who had lost their jobs or part of their salary. That kicked off a spiral of falling house prices and failing banks, which governments were forced to bail out, in turn piling up huge deficits.

But governments are starting to push back against the European Commission’s efforts to have more say about their economies. The tougher oversight of imbalances proposed by the commission may not make it into a competing set of rules being drawn up by a group led by Herman Van Rompuy, head of the European Council of heads of state and governments.

“This is unlikely to survive in the Van Rompuy task force,” said Benedicta Marzinotto, a research fellow at Brussels-based economic think-tank Bruegel.

Mr Van Rompuy launched his own task force on economic governance in May, when the Greek crisis was at its worst.

This task force, grouping EU finance ministers as well as economic and monetary affairs commissioner Olli Rehn and European Central Bank governor Jean-Claude Trichet, will meet one last time on Monday, before submitting its plans to the council at the end of the month.

Since it already includes members of governments – who keep a keen and jealous eye on their sovereign powers – analysts expect the task force’s proposals to be softer than those of the commission, where decision makers are appointed rather than elected.

The final rules adopted by the council and then by the European Parliament are likely to be watered down even further.

The commission also suggests that governments submit an outline of their annual spending early in the year. That way the EU can check whether they violate either the eurozone rules or the bloc’s economic objectives.

EU rules limit debt to 60% of GDP and deficits to 3%, but those rules turned out to lack teeth and several countries – including France and Germany – have broken them without being penalised.

The question now is how to give those rules more teeth. The commission suggests that those who do not listen to its warnings could be fined up to 0.2% of GDP, with fines taking effect automatically unless governments vote against them.

France and several other countries, however, oppose automatic sanctions, saying they are a political matter for governments.