* Italy, Germany reach deal on using existing flexibility in
* European Commission to prepare report on effectiveness of
rules by Dec 14
* Structural reforms should be rewarded with more time to
* Use of structural reforms clause opens risk of political
By Jan Strupczewski
BRUSSELS, June 27 European Union leaders agreed
on Friday that growth-boosting structural reforms should be
rewarded with more time to improve public finances under
existing EU budget rules in response to pressure from Italy to
shift emphasis from austerity to growth.
After four years of a sovereign debt crisis, when reducing
deficits was key for the euro zone to regain market confidence,
the biggest headaches for most governments now are record high
unemployment, moribund growth and high debt.
Under EU rules, governments have to strive towards a budget
close to balance or in surplus, excluding one-off revenue and
spending and the effects of the business cycle. They also have
to reduce public debt.
But the rules also say that governments can be given more
time to reach budget balance if they undertake reforms that have
a verifiable positive impact on economic growth -- an option
that has so far never been used.
Italy's Prime Minister Matteo Renzi, whose country has the
second biggest debt in Europe at more than 135 percent of GDP,
has been pushing for a more growth-friendly interpretation of
the fiscal rules since he took office in February, because
without faster growth Rome won't be able to pay down its debts.
Renzi, whose standing among EU leaders was boosted by the
strong support he received in European elections in May, is not
calling for a change in the rules, but for making use of the
unused leeway they offer in exchange for structural reforms.
ITALY, GERMANY HAVE A DEAL
Germany, the most ardent defender of tough budget policies,
has been worried that fiscal leniency could lead to a new
spending spree by governments taking advantage of low borrowing
costs and open the way for a new crisis.
But Renzi and German Chancellor Angela Merkel reached a deal
late on Friday on how the shift in emphasis in the EU fiscal
rules, called the Stability and Growth Pact, should be phrased
to balance the need for flexibility and fiscal prudence.
"The possibilities offered by the EU's existing fiscal
framework to balance fiscal discipline with the need to support
growth should be used," the leaders said in a section of the
final summit statement approved on Friday.
"Given the persistently high debt and unemployment levels
and the low nominal GDP growth, as well as the challenges of an
ageing society and of supporting job-creation, particularly for
the young, fiscal consolidation must continue in a
growth-friendly and differentiated manner," the text said.
"Structural reforms that enhance growth and improve fiscal
sustainability should be given particular attention, including
through an appropriate assessment of fiscal measures and
structural reforms, while making best use of the flexibility
that is built into the existing Stability and Growth Pact
The structural reform option, however, will be of little use
to France, which has been backing Renzi's push for more
flexibility, because it only applies to countries that have a
budget deficit smaller than 3 percent of GDP.
Paris, which has a deadline of 2015 to cut its budget
shortfall below that level, will have to wait until then to take
advantage of that option.
RISK OF MORE POLITICS IN RULES
Some EU policymakers worry that using the structural reform
clause opens the way for a more political approach to the rules.
This is because it is very difficult to quantify with any
degree of accuracy what effect a structural reform will have on
growth, especially in the longer-term.
The amount of leeway granted in structural deficit reduction
can therefore be politically influenced.
It will be up to the next European Commission, the executive
body that is the guardian of EU laws, to ensure the rules are
nor abused, a German diplomat said.
Economists point in the same direction.
"The rules are fine. The way in which they are policed and
enforced is not. The challenge is to improve the process in a
way that minimises the inevitable political strains," Berenberg
Bank chief economist Holger Schmieding said.
"Strengthening a country's growth potential through
structural reforms matters more than short-term austerity,"
Schmieding said. "In the political decisions on the pace of
fiscal correction, the current fiscal rules already offer the
required flexibility to reward countries that pursue genuine
During the debt crisis, the European Union sharpened its
fiscal rules twice and the Commission is to prepare by Dec 14 a
review of how the rules are working.
While the report, to be sent to EU leaders and the European
Parliament, will be descriptive, rather than contain proposals
for changes, it could form the basis of amendments later, if EU
governments decide on it.
(Reporting By Noah Barkin in Berlin, Giselda Vagnoni, Alastair
Macdonald, Gregory Blachier and Jan Strupczewski in Brussels;
Editing by Paul Taylor)