EU wants fiscal pact in force by Jan 2013: draft

European Union flags are seen outside the European Commission headquarters in Brussels ahead of an EU heads of state summit, October 27, 2010.

BRUSSELS (Reuters) - A European Union treaty to tighten budget controls in the euro zone should be in place by January1, 2013, according to a draft agreement that spells out concessions in an effort to win broad support within the debt-laden bloc.

Drafted amid a deep-seated crisis that threatens the currency union's future and has sent borrowing costs soaring for many states, the document obtained by Reuters on Wednesday sets out a temporary escape clause for members that cannot meet the stricter new standards.

It would allow euro zone countries to spend more than they earn during severe economic downturns.

States including Italy, which has debt in excess of 110 percent of national output and servicing costs close to unsustainable levels, had lobbied against stricter treatment of heavily indebted countries.

"There were concerns that the rules would be stricter than the current EU laws on debt," said one Italian diplomat. "The new treaty will keep the current rules, including mitigating factors."

The treaty, which is being pushed through largely at Germany's insistence, will also make it possible to bring spendthrift countries to court, a move Berlin believes adds clout to the new regime of stricter spending rules.

But reaching agreement among the 26 other states that are expected to sign up to the pact for the euro zone is complicated, and delays could further add to the political uncertainty that has unnerved investors throughout the crisis.

In an apparent attempt to court Britain, which opted out of the pact at a summit last December and is now at odds with the push for closer cooperation among the rest of the EU, a reference to single market integration has been removed.

Germany still holds out hope that Britain might be persuaded to join the fiscal treaty, although this seems unlikely.

Removing an earlier clause referring to deeper integration in the internal market may in part be a gesture towards Britain, which opposed the measure and feared it could become isolated as the rest of the EU forged closer ties.

"There should not be parallel structures and parallel policies (in the EU)," said one EU official, speaking on condition of anonymity.

BALANCED BUDGET

A balanced-budget rule demanding that governments do not spend more than they earn is central to the agreement, but under the new draft that could be waived during severe downturns in the euro zone or other exceptional events out of their control.

The document also spells out more clearly when the euro zone would tolerate a fiscal "deviation."

"Temporary deviation from the medium-term objective will only be allowed in cases of (an) unusual event outside the control of the contracting party with a major impact on the financial position of the general government or in periods of severe economic downturn for the euro area, the EU or the concerned contracting party."

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

Germany wants to restrict assistance from the ESM to countries that have signed up to the fiscal pact.

"There has to be a link with possible solidarity support in the euro area," the country's foreign minister Guido Westerwelle said on Wednesday.

It appears unlikely, however, a state that needed help would be refused it if its government intended to ratify the treaty.

In the current draft, which could still be amended, the treaty will come into force once 12 of the 17 euro zone countries have ratified it.

The aim is for that threshold to be met by the first day of next year. Other countries could join the pact when they see fit.

(Reporting By John O'Donnell and Julien Toyer; additional reporting by Francesca Landini in Milan; editing by Robin Emmott, John Stonestreet)