EU Leaders Seek To Finalize ESM, Fiscal Pact

BRUSSELS (Dow Jones)--European Union leaders gathered for a summit Monday to finalize accords on tighter fiscal discipline and a permanent bailout fund even as a looming multibillion-euro debt-restructuring deal for Greece threatened to overshadow the talks.

Leaders are expected to sign off on the final text of a fiscal compact, supported by the majority of E.U. economies, that aims to prevent a repeat of the public-finance meltdowns that have dogged Greece, Portugal, Ireland and others.

They are also likely to endorse a treaty creating the European Stability Mechanism, although a proposal to boost the size of the EUR500 billion firewall is still being debated.

In a joint statement to be issued after the summit, the leaders will note that there have been "tentative signs" of economic stabilization in Europe but financial-market tensions continue to weigh on the economy, according to a draft seen by Dow Jones Newswires, which is also expected to outline measures to support economic growth.

European Commission President Jose Manuel Barroso has promised to take steps to boost job creation and growth, including redirecting unused E.U. funds to tackle youth unemployment.

But Greece's debt crisis is increasingly taking center stage again, even though a new bailout for the country isn't officially on the agenda Monday. Greek Prime Minister Lucas Papademos headed for Brussels after weekend talks with private creditors over a plan to write off EUR100 billion worth of the country's debt edged toward conclusion. On Sunday, he won renewed commitment from Greek political leaders to pursue fresh reforms.

But complicating those discussions are new demands by Germany for greater oversight over Greece's budget affairs, and growing concerns that Greece's funding needs might be bigger than originally thought.

A German proposal was circulated last week among euro-zone finance ministry officials calling for Athens to cede some control over its budget decisions to Europe in return for a second bailout, one official told Dow Jones Newswires.

In an interview with The Wall Street Journal, German Finance Minister Wolfgang Schaeuble issued an unusually blunt warning that the euro zone might refuse to grant Greece a fresh bailout, pushing Athens into default unless it persuades Europe it can overhaul its state and economy.

"Greece needs to decide," Schaeuble said when asked whether the euro zone would grant or withhold the second bailout package for the country since 2010, expected to be in excess of EUR130 billion.

"Unless Greece implements the necessary decisions and doesn't just announce them ... there's no amount of money that can solve the problem."

On his way into Monday's talks, Swedish Prime Minister Fredrik Reinfeldt also expressed frustration with Greece. "They've repeatedly not delivered on their promises," he said.

But not everyone appeared to welcome the idea of a special budget czar to oversee the country's implementation of budget policy.

"I am strongly against the idea," Luxembourg Prime Minister Jean-Claude Juncker said ahead of Monday's talks. "It is not acceptable, not for Greece, not for me."

Austrian Chancellor Werner Feymann said that Greece's budget policies should be monitored but appointing a commissioner for one country isn't a good idea.

German Chancellor Angela Merkel wouldn't be drawn into the discussion of closer supervision for Greece, saying there was still work to be done.

"I believe we are having a discussion that we shouldn't be having," Merkel told reporters, noting that inspectors from the troika of Greece's international lenders--the E.U., the European Central bank and the International Monetary Fund--were still in Athens.

Greece's Papademos was expected to brief other leaders on progress in debt talks and also hold a separate meeting with Merkel on the sidelines of the summit, a euro-zone official said.

An initial agreement on a new bailout loan for debt-ridden Greece could be reached as early as this week and then discussed at a special summit of euro-zone leaders next month, officials from the euro zone and IMF said.

Final agreement on a proposed 50% write-down in the face value of debt held by Greece's private-sector creditors is now waiting on an updated report from the IMF on Greece's debt sustainability, these officials said.

Merkel, however, was optimistic that all remaining questions on a fiscal compact would be finalized Monday.

According to the latest draft of the fiscal compact, the European Court of Justice will be empowered to impose sanctions on fiscally wayward countries. The penalties could be "a lump sum or a penalty payment" and will be capped at 0.1% of GDP.

The draft also says that any country that wants to tap the ESM after March 2013 must first ratify the fiscal compact. It says the pact will come into effect when it has been ratified by national parliaments of 12 countries.

The fiscal pact came out of a Dec. 8 summit that saw the U.K. veto efforts to make changes to E.U. treaty law to encompass the new fiscal rules. At the time, the E.U.'s other 26 countries indicated they wished to sign what is in effect an intergovernmental accord, but there have been signs that others will join the U.K. in rejecting it.

The key aims of the pact are to limit governments' room for running deficits and to ensure they write into laws--or in some cases national constitutions--pledges to run balanced budgets and reduce their debt burdens.

The latest draft keeps intact the rules on deficit spending. It says countries must maintain a structural deficit "with a lower limit of 0.5% of the gross domestic product," adding that when a country's debt-to-GDP ratio is well below 60% the structural deficit rule can be loosened to 1% of GDP.

The pact also says that signatories must have debt-to-GDP levels that do "not exceed 60%" or are "sufficiently declining towards 60%."

An E.U. official said two main issues are still unresolved on the fiscal compact ahead of Monday's summit.