Europe's New Treaty to Tighten Budget Rules: Q-and-A

European Union ministers meeting on Monday will attempt to reach agreement on a new treaty enforcing stricter budget controls in the Eurozone that could allow the bloc's highest court to fine countries that do not adopt key rules.

In a move to tighten the pact, the European Court of Justice (ECJ) may be given power to punish a country that does not respect a balanced-budget rule in its national law, with a penalty of as much as 0.1 percent of gross domestic product (GDP), the latest treaty draft showed.

All EU countries except Britain are due to sign off on the pact when leaders meet at a summit on Jan. 30. But preparatory talks last week ended with some differences still unbridged.

What does the pact aim to do?

Central to the treaty is the enforcement of the rule for a broadly balanced budget, which says countries should not spend more than they earn in tax and other revenue over the medium term.

The treaty sets a deficit limit at 0.5 percent of a country's GDP in structural terms.

The agreement is also expected to call on countries to enshrine the balanced-budget rule in their national constitutions or law, although there is some leeway.

Both measures are designed to make the policing of spendthrift states legally watertight, an attempt to prevent a repeat of the sovereign debt crisis of the past two years.

Germany has insisted on the pact, which would make it possible for signatories to take other countries to the ECJ, the EU's highest court, if they believe the rules are being breached.

This is primarily targeted at a German audience, who are sticklers for rules, courts, and enforcement, said Sony Kapoor of Re-Define, an economic think tank.

This agreement does not break any new ground. Most of it is already in EU law. But winning over the German public is important for tackling the crisis.

Will it work?

As Kapoor said, much of what is in the new pact is already part of EU law. The European Commission recently won increased powers to sanction heavily indebted Eurozone countries that fail to tackle their finances.

The pact is designed to enhance these powers through the involvement of the ECJ, building on recent moves to give the European Commission and its top economics official, Olli Rehn, a more central role in enforcement.

But Germany and the European Central Bank (ECB) had expressed concerns that the new treaty was being eroded by an escape clause that would allow countries to suspend the fiscal rules in the event of exceptional economic circumstances or a downturn.

You should not have too much discretion in the fiscal compact through, for example, the escape clause, said a German official, speaking on condition of anonymity.

Keeping the ECB happy with the treaty is important as policy makers believe the central bank's willingness to go on buying the bonds of Italy, Spain, and other distressed Eurozone states depends in large part on having a strict new fiscal pact.

What concerns were expressed by the ECB?

As well as winning Germany's blessing, it is important to persuade the ECB that the pact marks a new chapter of closer economic coordination among the 17 countries using the euro.

In a letter last week to the diplomats and officials negotiating the new pact, the bank laid down its demands, some of which have been addressed in the latest draft.

The ECB asked for powers for the EU's executive body, the European Commission, to set a timetable for countries to balance their budgets. This is now part of the draft pact.

The central bank also wanted a tighter definition of the circumstances when an escape clause would be triggered.

It called for a new rule making it necessary to have the backing of a qualified majority of states to deviate from the new budget standards, to make it harder to use the escape clause.

The latest draft refers to a corrective mechanism that will be triggered automatically if countries deviate from the new budget rules.

The softening of language instructing countries to write the new rules into their constitutions is also a cause for concern.

What are the other obstacles?

Some states had been worried that Germany and France will use the new treaty to push through other political goals.

Diplomats had feared the treaty will be used to lay the foundations for common European tax policies, an ambition of Germany's. That could hurt countries such as Ireland, which has attracted multinational firms with low corporate-tax rates.

Britain, which will not sign up to the pact, is concerned that it will further diminish the country's influence in Europe.

It has hinted it could oppose the use of EU institutions such as the ECJ and the European Commission by those countries that sign up to the new treaty, since EU institutions are supposed to be for all 27 EU states.

Will the treaty convince financial markets?

The treaty in itself is unlikely to restore market confidence and a lengthy debate or delay could further undermine weak sentiment. The pact is expected to come into force next Jan. 1.

Investors' attention is more on whether passage of the treaty persuades Germany to offer further financial help to the Eurozone, perhaps by backing the issuance of common bonds within the single currency area.

The timing of the new fiscal treaty is also linked to the Eurozone's permanent rescue scheme, the European Stability Mechanism (ESM), which is due to be started in July this year.

The latest draft proposes restricting assistance from the ESM to countries that have signed up to the fiscal pact.

I think that the goals of debt discipline will be achieved in the long run, said Daniel Gros of the Brussels-based Center for European Policy Studies think tank.

But not thanks to the treaty, rather due to the pressure from markets and the experience of countries like Italy. The treaty itself will be irrelevant.

(Reporting by John O'Donnell; Editing by Stephen Nisbet and Peter Graff)