What is the fiscal compact treaty?

Tue, Feb 28, 2012, 00:00

The European Union fiscal treaty was agreed by 25 of the 27 European Union states in January this year after Britain and the Czech Republic refused support.

The treaty is designed to prevent a repeat of the Greek debt crisis and protect against the potential collapse of the euro currency.

Member states are obliged to keep their budget deficit below 3 per cent of gross domestic product (GDP) and ensure their public debt does not exceed or is sufficiently declining towards 60 per cent of GDP.

Participating governments must adopt a permanent golden rule to limit public debt and budget deficits. And there is an obligation to introduce an automatic corrective mechanism to reverse any deviation from an EU-approved recovery plan if a government’s debt or deficit breaches the limits.

“The rules ... shall take effect in the national law of the contracting parties at the latest one year after the entry into force of this treaty through provisions of binding force and permanent character, preferably constitutional, or otherwise guaranteed to be fully respected and adhered to throughout the budgetary process,” the treaty says.

The European Commission will monitor compliance with this provision.

Legal action can be taken in the European Court of Justice against governments which breach it.

Any member state which believes another has not complied with the court’s ruling can ask it to impose financial sanctions on that government.

The court may impose a penalty “appropriate in the circumstances” and which does not exceed 0.1 per cent of the country’s GDP.

The pact lays heavy emphasis on the achievement of medium-term objectives proposed by the European Commission to bring a country’s structural deficit to 0.5 per cent of GDP at market prices. This is a reference to the budget deficit net of one-off and temporary measures.

“Progress towards and respect of the medium-term objective shall be evaluated on the basis on an overall assessment with the structural balance as a reference, including an analysis of expenditure net of discretionary revenue measures, in line with the provisions of the revised stability and growth pact,” the treaty says.

Any euro zone country which breaches its deficit criterion under the stability pact faces penalties proposed by the commission. Only a qualified majority of other euro zone countries can block the commission’s recommendation.

Treaty participants may temporarily deviate from their country-specific objectives “only in exceptional circumstances” and provided the deviation does not endanger medium-term fiscal sustainability.

Such circumstances are defined as “unusual event” outside a government’s control which has a big impact on its finances or a severe economic downturn.

“In the event of significant deviations from the medium-term objective or the adjustment path towards it, a correction mechanism shall be triggered automatically,” the treaty says.

“The mechanism shall include the obligation of the contracting party concerned to implement measures to correct the deviations over a defined period of time.” As per existing legislation, a country whose national debt exceeds the EU limit of 60 per cent of GDP is obliged under the treaty to reduce it at an average rate of one-twentieth per year.

The treaty must be ratified by January 2013 and will take effect once it is ratified by 12 of the 17 euro zone countries.