* IMF suggests EU should keep debt and structural deficit targets only
* EU's Rehn says there is plenty of room for EU rule simplification
* Italy wants more leniency in EU fiscal rules for reforming countries (Adds EU's Rehn, details, background)
By Jan Strupczewski and Martin Santa
BRUSSELS, June 10 The European Union should simplify fiscal rules and focus on cutting debt, the International Monetary Fund said on Tuesday, joining a European debate on how to make austerity policies more growth-friendly.
Some countries, like highly indebted Italy, want more leniency on budget discipline for those who reform their economies, arguing higher growth would help reduce debt.
But a bad experience with France, which last year got two more years to reduce its deficit on promises of reforms and then failed to deliver, made EU policy-makers wary of trusting pledges that are not backed by action.
The IMF's head of the European department, Reza Moghadam, said focusing mainly on debt would give EU governments the flexibility they need to keep their economies growing, while retaining the confidence of markets and making the rules easier to explain to citizens.
"Simplify the rules while keeping some flexibility-make the public debt-to-GDP ratio the ultimate objective and reduce the number of operational targets," Moghadam told an economic conference.
He said the EU ceilings for public deficit and debt set at 3 percent of GDP and 60 percent of GDP respectively, were agreed in the 1990-ties on the assumption that nominal economic growth would be 5 percent.
"However, downward revisions of nominal long-term growth to around 3 percent in many euro area countries suggest that debt would instead converge toward 100 percent of GDP," he said.
Four years of the sovereign debt crisis have increased the debt-to-GDP ratio in the 18 countries using the euro by 30 percentage points to well above 90 percent, making debt sustainability one of the main headaches for governments.
ITALIAN PUSH FOR FLEXIBILITY
Italy, which takes over the EU's rotating presidency in the second half of the year, is a country with the second highest debt in Europe after Greece, expected to reach 133.7 percent of GDP this year after two years of recession.
Italian Prime Minister Matteo Renzi said last month that Italy would propose in October that countries that undertake structural reforms be given more flexibility on EU rules, which usually means more time to reduce the budget deficit or debt.
"We respect the rules and it's precisely because we respect them that we can say that a lot of these rules need to be changed," Renzi said.
"At the European Council meeting in October we'll try to propose an initiative which goes in this direction: more incentives for those which undertake decisive reforms," he said.
Officials from the European Commission, which has the task of making sure that EU laws are observed, have said that while Italy has to deliver on its deficit and debt reduction promises, adjusting the rules was a good idea.
"There is plenty of room for simplifying and streamlining," EU Economic and Monetary Affairs Commissioner Olli Rehn, told the same conference.
The IMF pointed out that EU countries now had to keep their nominal budget deficits below 3 percent of GDP, they had a spending benchmark as well as various deficit targets set under an EU budget disciplinary procedure and various targets for the budget's structural balance and how it should change.
"The labyrinth of rules is difficult to communicate to the public, and the number of rules needs to be cut down. Debt dynamics, i.e., the evolution of the debt-GDP ratio, should be the single fiscal anchor, and a measure of the structural balance the single operational target," Moghadam said.
He also noted that the EU should strengthen the mechanisms for enforcement of the rules. Even though the EU has the possibility of fining for repeated breaking of the rules, it has never punished any country.
To the contrary, when in 2003 France and Germany broke the budget rules, the conflict ended with changing the rules rather than fines for the rule-breakers.
"There are no easy solutions here, especially in a framework founded on peer pressure and moral suasion. More automaticity in enforcement could help: if sanctions cannot be avoided ex post, then they are likely to be more effective ex ante," Moghadam said. (Reporting By Jan Strupczewski; Editing by Tom Heneghan)