BRUSSELS European Union diplomats are trying to reach agreement on a new treaty enforcing stricter budget rules in the euro zone and other participating countries, but obstacles remain to securing a deal amid efforts to soften some of the measures.
All EU countries except Britain are expected to sign off on the pact when leaders meet at a summit on January 30. But preparatory talks ended last week with differences still unbridged and the European Central Bank unhappy with the direction of the talks.
WHAT DOES THE PACT AIM TO DO?
Central to the treaty is the enforcement of the rule for a broadly balanced budget, which says countries should not spend more than they earn in tax and other revenue over the medium term.
The treaty sets a deficit limit at 0.5 percent of a country's gross domestic product in structural terms.
Germany has insisted on the pact, which would make it possible for signatories to take other countries to the European Court of Justice (ECJ), the EU's highest court, if they believe the rules are being breached.
"The treaty has symbolic value for the Germans," said Daniel Gros of Brussels think tank, the Centre for European Policy Studies. "The other countries are going along with it because they hope it will allow Germany to do more for them."
"A small group in Berlin believes it is necessary to give the European Court of Justice power. And it might give (German Chancellor Angela) Merkel the justification to help other countries more."
The agreement is also expected to call on countries to transpose the balanced-budget rule into their national constitutions, although there is some leeway.
Both measures are designed to make the policing of spendthrift states legally watertight, an attempt to prevent a repeat of the sovereign debt crisis of the past two years.
WILL IT WORK?
Much of what is in the new pact is already part of existing European Union law. The European Commission recently won increased powers to sanction heavily-indebted euro zone countries that fail to tackle their finances.
The pact is designed to enhance these powers through the involvement of the European Court of Justice, building on recent moves to give the European Commission and its top economics official, Olli Rehn, a more central role in enforcement.
But the ECB is concerned that the new treaty is being eroded by an "escape clause" that would allow countries to suspend the fiscal rules in the event of exceptional economic circumstances.
Keeping the ECB onside with the treaty is important as policymakers believe the central bank's willingness to go on buying the bonds of Italy, Spain and other distressed euro zone states depends in large part on having a strict new fiscal pact.
WHY IS THE ECB CONCERNED?
As well as winning Germany's blessing, it is equally important to persuade the ECB that the pact marks a new chapter of closer economic coordination among the 17 countries using the euro -- an economic union that underpins the monetary union.
In negotiations with national diplomats in Brussels last week, the ECB made a series of recommendations to "toughen up" the treaty, one official said.
Speaking to a German newspaper, ECB executive board member Joerg Asmussen warned that the pact was being softened.
Asmussen, who formerly worked for Germany's finance minister, said loosening the spending rules in extraordinary circumstances amounted to a "substantial watering down."
The softening of language instructing countries to write the new rules into their constitutions is also a cause for concern.
WHAT ARE THE OTHER OBSTACLES?
Some states are worried that Germany and France will use the new treaty to push through other political goals.
Many are worried that the treaty will be used to lay the foundations for common European tax policies, an ambition of Germany's. That could hurt countries such as Ireland, which has attracted multinational firms with its low tax rates.
"There is a reference to a common economic policy ... one implication of that is that you have some form of common tax ... which is not acceptable to many countries," said one diplomat, commenting on last week's draft of the agreement.
Britain, which will not sign up to the pact, is concerned that it will further diminish its influence in Europe, especially if the countries that sign up to it decide to forge closer cooperation on the single market without Britain.
As a consequence, Britain has hinted it could oppose the use of EU institutions - such as the ECJ and the European Commission - by those countries that sign up to the new treaty since EU institutions are supposed to be for all 27 EU states.
WILL THE TREATY CONVINCE FINANCIAL MARKETS?
The treaty in itself is unlikely to restore market confidence and a lengthy debate or delay could further undermine weak sentiment. The pact is expected to come into force on January 1, 2013, once 12 countries have ratified it.
"Leaders are still focused on how they prevent the next crisis, debating how the stability and growth mechanism should look like in the future, rather than resolving this one," said Garry Schinasi, a former IMF official, who now advises central banks and governments.
Investors' attention is more on whether passage of the treaty persuades Germany to offer further financial help to the euro zone, perhaps by backing the issuance of common bonds within the single currency area.
"I think that the goals of debt discipline will be achieved in the long run," said Gros. "But not thanks to the treaty, rather due to the pressure from markets and the experience of countries like Italy. The treaty itself will be irrelevant."
(Reporting By John O'Donnell; editing by Stephen Nisbet)