Market Analysis

The Battle of the (Budget) Bulge

The EU summit came to a close on Friday. And what emerged was another demonstration of the will to back the euro.

Friday ended another two-day EU summit of all 27 member nations’ leaders amid yet another media-dubbed “important” or “crucial week for the euro.” And following a marathon overnight session, leaders emerged with some results.

The media take on the plans emerging has been predictably polarized—some characterizing the summit as “disastrous” while others simply say it’s big. Dramatics aside, what emerged was a framework to address some (though not all) of the eurozone’s issues.

EU leaders agreed to pledge an additional €200 billion in credit lines to the IMF—with three-quarters coming from eurozone nations. The European Stability Mechanism (ESM), the permanent eurozone bailout fund designed to replace the temporary EFSF, underwent several changes. The start date was bumped forward from 2013 to July 2012, pending member states’ formal approval. Leaders also proposed boosting the ESM’s resources above €500 billion. And ESM distributions to troubled nations—previously requiring unanimous approval—would need an 85% majority of member nations’ thumbs up.

But seemingly bigger news out of the summit was the development of tighter fiscal rules for governments—a new front in the eurozone’s battle of the budget bulge. If enacted, each country will add language to its own national constitution including the European Commission’s basic guidelines, which must be approved by the European Court of Justice. Some of the basics of this new fiscal compact are:

  • Nearly automatic disciplinary procedures when countries are above the Maastricht Treaty’s 3% deficit limit.
  • Target national debt-to-GDP ratio of 60%.
  • If the annual structural deficit exceeds 0.5% of GDP, an automatic correction mechanism would trigger.
  • Member states with excessive debt must submit structural reforms and austerity measures for review.

EU leaders had initially sought to work these new rules into a revised Lisbon Treaty—a move requiring all EU nations’ uniform consent. However, the UK rejected the new rules as contrary to their national interests. (And who can blame them—after all, their currency isn’t the euro, they aren’t an uncompetitive economy and don’t share all peripheral Europe’s ills.) Several other EU nations are on the fence as well. But all eurozone and six other EU nations’ leaders agreed to the rules. So the rules will be enacted separately from the Lisbon Treaty.

Ultimately, many details remain to be determined (whether the disciplinary procedure is a time out, smack on the budgetary rear or a fiscal tazing isn’t clear). And how they implement these measures is an open question, considering 23 national constitutions need amendment. Moreover, nothing in this plan is a cure-all for the eurozone’s ills, and it isn’t designed to be.

That said though, expecting a one-shot panacea for the eurozone isn’t terribly reasonable anyway. After all, if there were one, chances are they’d have dispensed it already. But boosting economic competitiveness and dialing back decades of quasi-socialist policies aren’t likely to be achieved overnight. Or in a two-day meeting. It isn’t really feasible to make Greece fiscally and economically like Germany with the swipe of a pen. However, pending parliamentary approvals, it seems eurozone politicians have agreed to a framework involving the surrender of some budgetary sovereignty. Is this wise? Folks will debate that, but leaders evidently found it necessary. Further, how they implement this remains to be seen. But that they took this step is another illustration of the broad political will to back the euro.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.