EU makes progress on reforms but hurdles remain

Europe is gradually putting in place the building blocks of a stronger defence against future economic crises, but its battle with huge sovereign debts and bulging deficits is far from over.

A deal on Monday to change the European Union's budget rules to sanction member states which breach debt and deficit limits should bolster attempts to prevent a Greek-style debt crisis elsewhere in the eurozone, even though the plan was watered down at the last moment.

After a deal reached by France and Germany, EU leaders are also turning their attention to amending the bloc's treaties so that a permanent system can be created for dealing with an economic meltdown if the new budget rules fail.

"Overall I believe we are on track, we have been learning lessons from the crisis," European Commission President Jose Manuel Barroso, who heads the EU executive, said this week.

"If and when realised in full, the result of all this work will be what we need: a system that provides incentives for member states to conduct sound economic and fiscal policies and a system that provides incentives for investors to observe responsible lending practices."

The moves build on the ad-hoc solutions that were agreed in May to save the euro from collapse an 80 billion-euro (USD 112 billion) bilateral loan package for Greece and a 500-billion euro safety net for all euro zone states backed by the IMF.

National governments have bitten the bullet by announcing coordinated austerity plans that have calmed financial markets' worst fears of a new government debt crisis to follow the one in Greece.

Other steps this week to protect Europe against an economic meltdown also included a deal to regulate private equity and hedge funds and the start of moves to increase a watchdog's powers to intervene in failing banks.

A long way to go

Although these moves go some of the way to dealing with the potential threats facing Europe, and tackle some of the root causes of the economic downturn in 2008, many of the measures have been criticised, watered down or face obstacles.

The 27-country EU, and the 16 that use the euro, still have plenty to do to regain the full confidence of investors.

"The weakness of the euro we experienced in the spring ... has not been overcome yet," German Chancellor Angela Merkel said on Wednesday. "The euro is protected at the moment by rescue mechanisms."

European Central Bank President Jean-Claude Trichet also dampened any triumphalism over the EU finance ministers' agreement on Monday on budget-rule reform by saying he did not fully support the new rules.

Under a deal reached in the French town of Deauville, French President Nicolas Sarkozy backed German calls to amend EU treaties to strip persistent deficit sinners of voting rights, and Merkel accepted French demands to water down sanctions on the sinners.

This raised doubts about whether the new version of the EU's Stability and Growth Pact will be any more effective in imposing fiscal discipline on governments or less prone to political fudging than two previous attempts.

Some member states and EU lawmakers saw the deal as a stitch-up by Merkel and Sarkozy, reinforcing the impression that Europe remains weak, divided and unable to speak with a coherent voice.

But others defend the agreement as the best possible under difficult circumstances, because differences in the French and German visions of the euro zone had threatened to stand in the way of any deal at all being reached.

"We have got an agreement on tighter budget rules and that is a good thing that cannot be ignored. However it came about is not really the issue, it's the substance," said one European minister, speaking on condition of anonymity.

Protests in France are litmus tests

Key to the success of European efforts to put the economy on a sounder footing is the ability of national governments to push through austerity measures, such as those announced by Britain on Wednesday.

Economic growth has revived in the EU, home to 500 million people, and the bloc's economy is officially forecast to grow 1.8% this year after a 4.2% contraction in 2009.

But EU unemployment is running at 9.6% of the workforce, and at around twice that rate in Spain, Latvia and Estonia. Unions say austerity will curb job creation.

Governments that are new, such as those in Britain and Greece, appear to have more support from voters for tough reforms than longer-serving administrations in countries such as France, Spain, Portugal and Ireland.

Protests against an unpopular pension reform planned by the French government have made France the front line in the battle over austerity. If Sarkozy backs down or waters down the reform, it will embolden unions and protesters elsewhere. If he stands firm, it could encourage other governments to tough it out.

Other governments are also under pressure. Spanish Prime Minister Jose Luis Rodriguez Zapatero, facing a large public deficit and a stagnant economy, overhauled his cabinet on Wednesday to try to strengthen its appeal.

Along with Greece, Portugal and Ireland, Spain is seen as a potentially weak link in the euro zone.

But Portugal's government has raised hopes that it will win support for its 2011 budget by agreeing this week to open talks on the plan with the main opposition party, which is demanding lower tax increases and more spending cuts.

The pain of the economic downturn has been spread unevenly and the impact of trends such as ageing societies, poor demographics, sluggish growth and rigid labour markets lead some commentators to see Europe as in decline.

Before it can declare itself immune to future crises, the EU also needs to address imbalances under which some economies, such as Germany's, power on and countries such as Greece, Ireland, Spain and Portugal battle huge problems.