Merkel Cedes Ground in Pact on Debt Rules

By MARCUS WALKER And CHARLES FORELLE

For months, Germany has dominated Europe's response to the euro-zone debt crisis. No more.
Europe's rickety deal this week on new rules to rein in euro-zone public debt suggests that Germany's agreement to open its wallet to save the euro zone cost it the leverage it needed to overhaul the currency bloc.
German Chancellor Angela Merkel and French President Nicolas Sarkozy agreed to a fiscal pact for the euro zone that's barely tougher than the existing rules. Critics blame the present system for allowing Greece's problems to fester and argue that a tougher sanction regime is essential if Europe is to avoid similar crises in the future.

The awkward compromise casts further doubt on the ability of the euro zone to restore investor confidence in its finances, a vital step toward ensuring the currency bloc's long-term viability.The deal, struck at the French seaside resort of Deauville on Monday, preserves euro-zone leaders' right to vote on whether one of their number will face financial penalties for running excessive budget deficits. Until this week, Berlin had been pressing for automatic sanctions against countries that violate EU deficit limits, arguing that that would make the enforcement of fiscal discipline more credible.

Ms. Merkel's about-face surprised many of her countrymen, including members of her governing coalition.
On Thursday, Ms. Merkel's foreign minister and coalition partner, Guido Westerwelle, suggested the chancellor had given away too much to France.
Mr. Westerwelle told reporters in Berlin that penalties for excessive spending must not be held hostage to "political opportunity," referring to the danger that European politicians will vote to spare each other from the embarrassment of sanctions, as in the past, unless penalties are automatic.

A spokesman for Ms. Merkel said Mr. Westerwelle didn't raise any objections to the deal in cabinet this week. Ms. Merkel defended the proposed new fiscal rules on Thursday, saying they include "significant parts" of tough proposals put forward by the EU's executive arm, the European Commission.
Analysts say the climbdown shows that Germany lacks the power to corral an unwilling majority. When Greece and others faced possible national bankruptcy this spring amid capital flight, Germany was able to dictate the terms of bailout plans. Now that the bailout deals are in place, however, the EU's biggest member is finding it much harder to impose its will.
"Germany has had to acknowledge political reality: There was no chance of getting what they wanted past France, Italy or Spain," says Simon Tilford, chief economist at the Center for European Reform, a non-partisan think tank in London.

The European Central Bank added its voice to the chorus of critics on Thursday, saying that its president, Jean-Claude Trichet, "does not subscribe to all elements" of the package that EU diplomats adopted in the wake of the Franco-German accord. The ECB has no power to block the agreement, however. EU leaders are expected to ratify the package at a summit next week.
Berlin and Paris insist the agreement will speed up the procedure for enforcing EU rules that limit budget deficits to 3%, and total public debt to 60%, of gross domestic product. But policy makers who wanted a more ambitious overhaul are increasingly critical of the deal, and some observers are asking whether Mr. Sarkozy, who wants to preserve countries' wiggle room, has outfoxed Ms. Merkel.

Senior German officials admit the prospective new rules aren't ideal, but they say it was the best deal they could realistically get. Only Finland, Sweden and the Netherlands were keen on automatic sanctions, while a number of Southern European countries—the most likely to incur penalties for fiscal indiscipline— were opposed, these officials say.

German negotiators say they won a major concession from Mr. Sarkozy in return for a softer sanctions procedure: France agreed to support German proposals to change the EU treaty, to allow the suspension of profligate euro members' voting rights, and the creation of a permanent system for dealing with debt crises. However, EU treaty changes are a tortuous and unpredictable process, and other EU countries have yet to agree to specific amendments.

The permanent crisis-resolution system that Ms. Merkel wants to write into EU treaties would create a faster, simpler way than available now for indebted countries to renegotiate their debts with bondholders. German officials insist creditors, not just European taxpayers, must bear the risk when countries such as Greece live beyond their means.
The necessary treaty change isn't guaranteed to happen just because France now supports it, German officials say. But without French support, it was guaranteed to fail, these officials say.
The obstacles to treaty changes remain formidable, says Fabian Zuleeg, chief economist at the European Policy Center, a Brussels-based think tank. Treaty changes require unanimous support from EU members, and the weaker euro-zone countries may well object, he says.
A crisis mechanism that requires bondholders to take a hit could drive up the borrowing costs of countries such as Spain, Ireland or Italy. It would be "politically very difficult" for those countries' leaders to accept that or the loss of voting rights, Mr. Zuleeg says.

Irish law might require a referendum on treaty changes, Mr. Zuleeg says. That would be risky and painful: In Ireland's last EU referendums, voters first rejected proposed changes before finally approving them. (Fonte: Wall Street Journal)