TEXT-Fitch: central EMU budget would be significant integration step

Oct 26 - An agreement to set up a eurozone budget, while not a near-term
prospect, would be a significant step towards further EMU integration even if
its initial resources were small, Fitch Ratings says.

Although embryonic, the concept, which was mooted by European Council President
Herman Van Rompuy before the October EU Summit, has a well-grounded economic
rationale. A central budget would acknowledge that monetary policy may not
always enough for the eurozone to cope with asymmetric shocks. It would also be
able to focus resources towards a country experiencing a shock. For example, it
could temporarily fund active labour market policies to prevent unnecessary
destruction of human capital. And it would help prevent excessively pro-cyclical
fiscal policy in individual countries, and in the eurozone as a whole.

In light of the very full reform agenda that eurozone authorities are already
grappling with, a central budget will probably be less of a priority compared
with other initiatives such as banking union. As with the raft of existing
measures aimed at deepening economic and fiscal integration in the eurozone,
political and implementation challenges would be large, although the idea does
appear to have a degree of political support.

In their statement following the summit on 18-19 October, EU leaders agreed to
explore "further mechanisms" for an integrated budgetary framework for the euro
area, "including an appropriate fiscal capacity." Our baseline expectation is
that further institutional reforms of this type will allow the monetary union to
survive intact, but as we highlighted immediately after the October summit there
are risks of the reform process losing momentum.

If the central budget proposal is to survive, creditor countries will need
assurances that its "limited fiscal solidarity exercised over economic cycles"
will not amount to perpetual transfers from core to periphery. Any transfers
would have to be conditional on the recipient's full adherence to EMU's fiscal
governance framework.

Indeed, Van Rompuy's proposal explicitly stated: "Elements of fiscal risk
sharing can and should be structured in such a way that they do not lead to
permanent transfers across countries or undermine the incentive to address
structural weaknesses." That suggests that creditor countries would only back
the proposal if they thought economic adjustment processes would work, and that
transfers would ultimately cease.

Nevertheless, there is a precedent in the EU's budget (which amounts to roughly
1% of total GDP), which is not spent evenly across the union and therefore
represents a transfer between states and regions. Projects in EFSF programme
countries are receiving a greater proportion of their financing from the EU's
development funds.

Van Rompuy's remarks came in his Interim Report on progress towards a "genuine
Economic and Monetary Union", published on 12 October.