Czechs jump ship from fiscal pact

By bne IntelliNews January 31, 2012

bne -

The Czech Republic stole the headlines coming out of the EU summit in Brussels on January 30, surprising with a sudden announcement that it will not sign up to the Eurozone's fiscal compact. The move sees domestic politics in Central Europe impact the EU's fight against the debt crisis once more, with the decision clearly motivated by the bungled management of the issue by the ruling coalition in Prague.

More positively, 25 out of the 27 EU states pledged to sign up to the pact, whilst the markets will be pleased to see a compromise with Germany that allows the Eurozone's two bailout funds - the permanent European Stability Mechanism (ESM) and temporary European Financial Stability Facility (EFSF) - to run in parallel, pushing the Eurozone's firepower towards the €1 trillion mark, and perhaps inching the Eurozone towards a future fiscal union.

Breaking rank

The Central European states arrived at the summit marching in sync, with Poland leading a Visegrad posse - including Eurozone member Slovakia - which insisted that non-Eurozone countries signing up to the fiscal compact should get a say in the single currency's decision making process.

Poland was meant to be the difficult one, with Polish Prime Minister Donald Tusk warning right down to the wire that his country - which was one of the plan's biggest cheerleaders until recently - would pull out unless it is included in Eurozone summits. However, Warsaw managed to reach a compromise with the French-led resistance to its claim, under which non-Eurozone signatories will participate in Eurozone summits at least once a year, and take part in all summits which discuss competitiveness or changes to the "architecture" of the single currency.

That hiccup out of the way, Czech Prime Minister Petr Necas decided it was time to break rank to announce Prague's shock decision. Necas claimed that the refusal to sign the treaty that leads to the compact was motivated by three reasons, reports EU Observer. Firstly, because non-euro countries will not be able to participate in all Eurozone summits; second, the treaty does not pay enough attention to debt (Necas' country happens to have one of the healthiest debt positions in the EU); and lastly because it would face "complicated ratification" back home.

That last point is clearly key, which was made clear by Necas when he stressed that the Czech Republic would likely be back to join up in the future. "I could not express my approval of this treaty, but I consider it was extremely important that a consensus was reached on article 15 that it will be possible to opt in and to accede to this treaty without any requirement for negotiations. So this treaty remains open for future accession," the Czech PM said.

Whilst Prague is hardly the most pro-euro capital in the EU, it had appeared that the governing coalition was working through the deep splits that the compact plan has provoked since it was announced on December 9. Just toward the end of January, the Czech cabinet agreed on a loan to the IMF - albeit for €1.5bn rather than the €3.5bn requested.

However, following reports of deep divisions amongst the three-party governing coalition - which even suggested it could collapse - the question of joining the fiscal pact was due either to go to a referendum, or face a fight to gain a constitutional majority in the Czech parliament. With the euro-sceptic population already alerted to the idea of a referendum - and ready to vote it down - the potential stress of pushing the pact through parliament instead may well have proved too much for the coalition to withstand. Necas clearly felt discretion was the better part of valour in this instance.

25 out of 27 ain't bad

However, the impact on the Eurozone's fight against the debt crisis looks minimal, mostly thanks to the fact that everyone else - aside from the UK of course - agreed to take the plunge and hand a level of fiscal regulation over to Brussels.

The impact that Prague's refusal will have on the Czech Republic's relations with its Eurozone partners - with Germany being a vital prop for its economy - is more difficult to assess. "A treaty at 25 is quite an achievement, given that the Eurozone itself comprises of only 17 members," remarked EU council president, Herman Van Rompuy.

The intergovernmental treaty obliges signatories to enshrine a "balanced budget" rule in their binding legislation - "preferably constitutional" - and to create "automatic correction mechanisms" at national level in case they overstep the budget deficit limit.

The European Court of Justice can impose fines of up to 0.1% of GDP should these limits not be respected. Any penalties paid by Eurozone countries will flow into the European Stability Mechanism - the Eurozone's permanent bailout fund which will spring into life in July. Those paid by non-Eurozone members will end up in the EU budget.

The biggest news for the markets will be that German objections to allowing the ESM to initially run in parallel to the EFSF - thus boosting firepower to €750bn - were overcome by making access to ESM cash conditional on implementation of the fiscal pact. That compromise is the latest step in the bid to raise the ESM/EFSF ceiling to €1 trillion, itself a hint towards tighter potential fiscal union in the future.

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