The leaders of France and Germany agreed a master plan on Monday for imposing budget discipline across the euro zone, saying the EU''s basic treaty will need to be changed in the search for a sweeping solution to its debt crisis. President Nicolas Sarkozy and Chancellor Angela Merkel said their proposal included automatic penalties for governments that fail to keep their deficits under control, and an early launch of a permanent bailout fund for euro states in distress.
--- FT says S&P threatens to downgrade Germany, France and others
They said they wanted treaty change to be agreed in March and ratified after France wraps up presidential and legislative elections in June. "We need to go fast," Sarkozy said. Italy, the biggest euro zone nation in trouble, offered a glimmer of hope that the bloc could halt a crisis that is threatening the survival of the common currency. Its borrowing costs tumbled after its new technocrat government announced an austerity programme. But there was a stark reminder of what is at stake when the Financial Times said Standard & Poor''s had warned Germany, France and four other euro zone countries with the top AAA credit rating that they might be downgraded within 90 days, depending on the outcome of a crucial EU summit on Friday.
The FT said S&P would announce later on Monday that it had put six countries, also including the Netherlands, Austria, Finland and Luxembourg, on negative credit watch. French and German efforts have been aimed at averting precisely that eventuality.
"What we want, with the (German) chancellor, is to tell the world that in Europe the rule is that we pay back our debts, reduce our deficits, restore growth," Sarkozy told a joint news conference after about two hours of talks in Paris. Merkel added: "This package shows that we are absolutely determined to keep the euro as a stable currency and as an important contributor to European stability."
Confidence that European leaders will come up with a credible plan on Friday to lead the region out of its debt crisis lifted world stocks on Monday, with European shares hitting a five-week high. Investors and policymakers hope a summit deal on closer euro zone integration, combined with strict deficit reduction moves by heavily indebted states, will induce the European Central Bank to act decisively to stop bond market turbulence spreading.
"This agreement probably will give the ECB the political cover for intervening more actively on a temporary basis," said Uri Dadush, senior associate at the Carnegie Endowment''s International Economics Program in Washington "The bad news is that this is all temporary. It is difficult to see how a deal like this hangs together without a quid pro quo in terms of some movement towards euro bonds or some form of long-term fiscal support for the countries in trouble."
LACK OF PROGRESS S&P made the same point, telling the governments it would conclude its review "as soon as possible" after the summit. "(It) is our opinion that the lack of progress the European policymakers have so far made in controlling the spread of the financial crisis may reflect structural weaknesses in the decision-making process within the euro zone and European Union," it said, according to the FT.
Merkel and Sarkozy had already both wanted a system of more coercive discipline for euro zone governments that fail to keep down their budget deficits. But they had been under unprecedented pressure to see eye to eye in a crisis that has split them on issues such as the role of the European Central Bank in lending to troubled states, and whether the bloc should issue jointly guaranteed euro bonds.
Sarkozy and Merkel said they would send off their plan on Wednesday, in time for Friday''s summit, and made clear their determination to drive through an EU treaty change despite objections from some member states. If countries such as euro outsider Britain blocked a treaty change for the 27 EU members, the euro zone would proceed with an agreement among its 17 states, open to all who wanted to join, they said. Sarkozy said the economic policy mistakes that led to the euro zone crisis must never happen again, accepting that France and Germany, the euro zone''s two biggest economies, bore the biggest responsibility for finding a solution.