Fiscal folly?

As perhaps the eurozone's top crisis manager, German Chancellor Angela Merkel views the excessive debt run up by some countries as the real reason behind the EU's current fiscal woes. She aims to prevent financial crises of that magnitude in the future by enforcing more budget discipline on member states with the new fiscal pact.

There was widespread applause for the idea when it was approved last year by 25 of the 27 EU member countries. After all, it sent a signal to the super-nervous financial markets that Europeans can get their act together. But has that message ever arrived?

Markets not convinced

"The fiscal pact's credibility on the markets is next to zero," Deka-Bank Chief Economist Ulrich Kater said at a meeting of the Center for European Economic Research (ZEW) in Mannheim, Germany. He argues that the perception on the markets as to what the new European fiscal cooperation can achieve is different from what policymakers think it is.

The pact imposes fiscal regulations which are tougher than those included in the Maastricht treaty, the founding accord of the single currency union. Under the new fiscal pact, which comes into effect in 2013, signatories will only be allowed to increase their borrowing by 0.5 percent of the Gross Domestic Product a year, compared with a maximum of 3.0 percent at present.

Red herring?

So has the German policy of budget consolidation become an export hit? Far from it, says Clemens Fuest of Oxford University, who advises the German Finance Minister, Wolfgang Schäuble.

"The advantage of the fiscal pact was extremely short-lived: it just meant that people could talk about something other than eurobonds," Fuest argued.

Germans shy away from such bonds: They would be issued jointly by the countries in the eurozone, and that would mean that all of them would be liable for each other's debts. So is the fiscal pact just a red herring to draw attention away from something the Germans wouldn't like?

Not quite. The president of the ZEW, Wolfgang Franz, sees some good in it, for example, its mechanism of sanctions against underperformers. Under the pact, the European Commission would propose sanctions in the event a nation exceeds the agreed debt limit, and those sanctions can only be prevented by a majority of the bloc's economics and finance ministers. "This means there will be a higher likelihood of sanctions actually being imposed," Franz said.

Up to now, it's been the other way round: under the Maastricht treaty, sanctions have had to be positively approved by a majority of ministers. But with sinners judging sinners, no sanctions have been approved, although deficit criteria have been breached on 88 occasions. Germany is scarcely entitled to point the finger at others, since it was among the first nations to violate the Maastricht treaty's deficit rules.

Keeping the Germans quiet?

But what's the use of stricter rules if even the laxer ones haven't been implemented? The president of the Ifo economic think tank, Hans-Werner Sinn, is highly critical.

"The pact is nothing but a sedative pill for the German people which the government is offering them to get them to agree to its opening its purse," Sinn maintained.

He isn't a big fan of the new sanctions either. He says he cannot imagine proceedings ever being initiated against, say, France to punish it for excessive spending: "That's simply pulling the wool over people's eyes."

A case of blackmail?

Following initial resistance, former French President Nicolas Sarkozy pushed the fiscal pact as a joint Franco-German project. But since the election victory of Socialist Francois Hollande, German Chancellor Angela Merkel has had to listen to a different tune coming from Paris. Even though Hollande hasn't insisted on renegotiating the pact, he wants to see economic stimulus measures attached to it. And this is what will be agreed at the upcoming EU summit.

So is the pact out of date before it's even come into effect? "If you take a look at Italian or French newspapers, you understand that the Fiscal Pact is being viewed as irrelevant and as blackmail," says Clemens Fuest.

In the Irish referendum on the pact, the majority voted yes, but only out of fear that funds from the European Stability Mechanism would otherwise run dry. Berlin has seen to it that there'll be no more rescue packages for countries which don't join the fiscal pact.

"You can figure yourself how seriously people will take the pact in the long run if it only came about through blackmail," Fuest concluded.

Author: Zhang Danhong / hg
Editor: Michael Lawton