EU Member States Agree On Fiscal Treaty; UK and Czech Republic Refuse to Sign

EU leaders meeting in Brussels (Belgium) yesterday (30 January) agreed a fiscal compact designed to strengthen fiscal discipline and increase economic and budgetary co-ordination within the Eurozone. The agreement, now referred to as the "Treaty on Stability, Coordination and Governance in the Economic and Monetary Union", was agreed on by all EU member states except the United Kingdom and Czech Republic, which both refused to take part. The treaty will be signed in March and will take effect once it has been ratified by 12 Eurozone member states.

Fiscal Discipline

The agreement states that annual national budget deficits for Eurozone states must be between 0.5% and 3% of nominal GDP. Member states’ total debts will not be allowed to exceed 60% of GDP. Eurozone members will be required to introduce a balanced budget rule into their constitutions or in a way that would guarantee the rule would be "fully respected and adhered to throughout the national budgetary processes". This must be done within one year of ratification. These fiscal rules will apply apart from in the case of "exceptional circumstances", defined as an "unusual event outside the control of the Contracting Party".

Stricter Enforcement

The balanced budget rule will be subject to strict enforcement. Violation of the rule will trigger an automatic correction mechanism. If measures recommended by the European Commission to restore fiscal discipline are not undertaken by the Eurozone member in question, they may be taken to the European Court of Justice (ECJ), which will be able to administer fines of up to 0.1% of GDP as a penalty for non-compliance. The money from fines levied on Eurozone states will go to the Eurozone's new permanent bailout fund, the European Stability Mechanism, to be introduced in July 2012 as a replacement for the current bailout fund, the European Financial Stability Fund. Member states will only be able to avoid corrective measures and potential fines if a qualified majority of Eurozone states vote to allow this. Governments with debts in excess of 60% of GDP will be required to reduce it at a rate of one 20th per year, in accordance with the existing excessive-deficit procedure.

Summits and Economic Co-Ordination

In addition, the agreement stipulates that member states will report public debt issuance to the Commission and the Council, and will co-ordinate economic reforms between their fellow member states and EU institutions. Importantly, however, this call for greater co-ordination is not backed up with the same strict enforcement mechanisms that stand behind the budget rules in the agreement.

Eurozone member states will hold summits every six months. These will be presided over by a president, elected by member states, and may be attended by a representative of the European Parliament, which will in turn be provided with reports of the meetings. Non-Eurozone member states that have ratified the treaty will be able to participate in most of these meetings.

UK and Czech Rejection

The UK refused to participate in the new agreement when it was first initiated in December 2011, citing fears of threats to the City of London and the UK's financial sector, despite no explicit reference to either in the proposed agreement (see Eurozone - United Kingdom - Europe: 9 December 2011: Majority of EU Member States to Establish Landmark "Fiscal Compact"). Despite initially threatening to attempt to block the use of existing EU institutions such as the ECJ and Commission under the new treaty, the UK relented yesterday, promising only to monitor their use carefully and launch legal proceedings if UK interests are deemed to be threatened. According to Czech prime minister Petr Necas, the Czech Republic will not sign the pact "for the time being", as it does not allow non-euro countries to participate in all Eurozone summits, is not focused enough on the issue of debt, and because the process of ratification would face "complicated" obstacles in the Czech Republic. By these "obstacles", Necas meant the strong opposition of Eurosceptic president Václav Klaus, who had already pledged that he would not sign the treaty if approved by parliament. The Czech Constitution does not specify the timeframe within which the president must approve or reject legislation, which means Klaus could postpone the treaty's ratification until his presidential term expires in March 2013.

Outlook and Implications

Although notionally agreed, potential obstacles to the treaty's ratification remain, not least the Irish attorney-general now being set to examine the text to determine whether or not a referendum will be required for Irish ratification. Should this be deemed necessary, it is by no means certain that the result would be positive (see Ireland - Europe: 26 January 2012: Referendum Decision on EU Treaty Causes Legal Uncertainty in Ireland). In addition, it is not clear how easy it will be for each participating member state to introduce a balanced budget rule into law, as specified in the treaty. Some Eurozone member states are ruled by minority governments and may not command the parliamentary majority required to pass the law. Opposition parties may not hesitate to play politics with the requirements of the new fiscal compact. In addition, the European Parliament is likely to be vociferously critical of being denied a stronger presence and influence at the Eurozone meetings envisaged in the agreement. As an intergovernmental treaty, however, the parliament has little binding influence over its contents.

If the treaty is implemented, it is likely to ensure greater fiscal discipline within the Eurozone. Although this is important for the long-term stability of the monetary union, in the short term, an overly strong focus on budgetary discipline is likely to lead to yet more austerity measures, which may well exacerbate the Eurozone's growth problems. Moreover, the fiscal compact does nothing directly to increase the size of the bailout fund available for the Eurozone's struggling economies. Neither does the agreement help troubled Eurozone states carry out the deep-seated reforms necessary to restore their economies to competitiveness. On a more positive note, the compact may help to convince markets that the Eurozone is serious about tackling its debts, thus bringing down borrowing costs. There is also some hope that concrete moves to shore up Eurozone fiscal discipline and economic governance may prompt the ECB to take further measures to ease the liquidity problems facing several Eurozone states.

The fiscal compact states that it is to be incorporated within the EU treaties within five years. Given the strength of UK objections to further integration, however, this is unlikely to happen with a Conservative-led government in London. Indeed, despite declining to join the compact, Prime Minister David Cameron is likely to face criticism from dozens of his Eurosceptic backbench MPs, many of whom would like to see the UK repatriate powers back from Brussels or leave the EU altogether. Although the compact constitutes only a small step towards greater economic and fiscal union, it may come to be seen as a key moment in the UK's relationship with the rest of the EU.

The Czech prim minister's decision to stay outside the agreement could have considerable internal consequences and could even lead to the collapse of the government. The Czech junior coalition partner, TOP09, has already warned that it might exit the government if Necas rejects the treaty (see Czech Republic: 13 January 2012: Czech Coalition Divided over EU Budgetary Integration). TOP09's departure would leave Necas with only minority representation in the Czech legislature, which could slow down or halt his reformist intentions, cause political instability, and even lead to an early election.