Eurozone Leaders Enact New Financial Pact

The leaders of Europe’s single currency bloc agreed on a program of long term economic overhauls this weekend.

Eurozone leaders agreed Friday night on a program of long-term economic reform for the single currency zone. Their immediate focus was on the future of the bailout mechanism put in place after the crisis in Greece last year. Greece’s and Spain’s credit ratings were once again downgraded earlier in the week, urging the leaders of the monetary union to calm markets.

The heads of government agreed to reform the scope and increase the size of Europe’s existing rescue fund. The European Financial Stability Facility had some €440 billion at its disposal to aid governments that were unable to borrow on financial markets at an affordable rate. Ireland had to tap into the facility last November. Portugal may have to request a bailout this year.

Europe had been divided on the future of the bailout fund with Germany in particular pushing for a more comprehensive overhaul of economic governance throughout the eurozone.

The leaders agreed over the weekend to expand the bailout fund to a total of €500 billion and set up a separate, permanent facility of the same size in 2013 when the temporary fund expires. The current as well as future fund will be able to purchase bonds directly from eurozone countries and itself be financed by at least some capital contributions from member states instead of the current system of guarantees.

Along with French president Nicolas Sarkozy, Chancellor Angela Merkel previously proposed a pact to boost Europe’s competitiveness, including raising the retirement age across the eurozone, abolishing the indexation of wages to inflation, harmonizing corporate tax rates and instituting a “debt brake” that would limit the ability of national governments to plunge deep in the red.

At the previous meeting of government leaders last month, it became evident that Europe didn’t want Germany’s rules. The leaders agreed to a watered down version of the competitiveness pact over the weekend which proclaimed that the policy mix “remains the responsibility of each country.”

Under the new regime, the European Commission would supervise fiscal commitments that are national prerogatives. The existing Stability and Growth Pact sets a deficit limit of 3 percent of GDP and a debt limit of 60 percent of GDP. At times of crisis however many the nations that carry the euro have broken those rules.

Southern eurozone economies, which are among the bloc’s most heavily indebted, were wary of stricter budget rules as well as labor market and welfare reforms. Belgium, Portugal, Luxembourg and Spain objected to the wage indexation proposal while Austria criticized plans to raise the pension age across the continent.

Ireland, which sought better terms on the €67.5 billion bailout it received last year, was rebuffed when it refused to contemplate raising its corporate tax rate. Because of its low tax regime, Ireland has attracted foreign companies and investment, especially from the United States.

“It’s difficult to ask others to help finance a plan but not concern themselves with the tax side,” President Sarkozy told reporters after the summit. Heated debates between Ireland’s newly-elected prime minister and the French president reportedly caused the negotiations to drag on until the early morning hours.

The council did agree to cut the interest rate Greece pays on its bailout by a single percentage point. Athens had asked for two.

The new “pact for the euro” further separates those EU countries that are in the single currency club from those that aren’t. Poland in particular had been anxious about the Franco-German “competitiveness” effort. “Are we getting in your way?” Prime Minister Donald Tusk wondered. “You are humiliating us.”

Denmark and Sweden also feared isolation. Unlike Poland, they have no interest in joining the euro. Smaller economies as Estonia, Slovenia and Slovakia would now appear to have more influence on policy than longtime EU member states — including the United Kingdom.

In the long run, the euro pact might actually lead to more instead of less disunion among the European states. Countries as Poland may voluntarily join the pact to preserve the single market but it seems unlikely that Britain or Sweden would.