Germany, France to form new plan to help eurozone

[December 17, 2010]  BRUSSELS (AP) -- EU leaders have agreed to work for closer economic cooperation amid worries about high debts in countries that use the struggling euro.

French President Nicolas Sarkozy says he and German Chancellor Angela Merkel will present new proposals to reduce differences among the economies that use the euro.

Sarkozy says "we have to tackle the competitiveness gaps within the 16 eurozone nations."

Belgian Prime Minister Yves Leterme says, "Monetary union requires an economic union, nobody can avoid this destiny."

Both spoke after a summit of the leaders of the 27 EU nations ended Friday.

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THIS IS A BREAKING NEWS UPDATE.
AP's earlier story is below.

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BRUSSELS (AP) -- Even though EU leaders have agreed on a new rescue system for future debt crises, rating agencies' increasingly pessimistic view on some euro nations' ability to handle debts added pressure Friday to come up with more short-term measures to ease the crippling market turmoil.

EU leaders decided not to beef up the their existing bailout fund at a summit in Brussels, as they wrap up a punishing year that has rocked the world's confidence in their ambitious experiment to share a currency.

Markets seemed somewhat relieved by the one financial decision the EU leaders have made at this summit: to change the treaty that underpins their bloc to allow for a permanent rescue plan for countries that get buried in debt beyond 2013. Stocks and the euro rose slightly in European trading Friday morning, despite worries that the move doesn't do enough to deal with the current debt turmoil.

Rating agency Moody's Investors Service downgraded Ireland's government bonds by five notches Friday, citing the country's ailing banking sector, which was the main cause for a massive bailout from the EU and the International Monetary Fund last month. The downgrade follows warnings over the ratings of highly indebted Spain, Greece and Belgium earlier this week.

EU leaders Thursday night said they would do "whatever is required" to safeguard their common currency. But they stopped short of introducing new showstopping measures, such as boosting the size of the eurozone's existing euro750 billion ($992.85 billion) bailout fund or introducing pan-European bonds to ease vulnerable states' borrowing costs.

The heads of state did agree on tweaking the bloc's central treaty to allow them to set up a new tool to deal with debt crisis among the 16 countries that use the euro after 2013, when the existing bailout fund expires.

EU governments had decided to set up the so-called European Stability Mechanism at their previous summit in October and finance ministers outlined its broad features at the end of November.

The mechanism is more than a bailout fund. It will provide rescue loans to countries that face a crisis of liquidity -- that is, if they can't access money quickly enough to pay off their debts. Crucially, however, the ESM will also be able to force private creditors to assume some losses when a country is deemed insolvent.

"It is a major decision," Jose Manuel Barroso, the head of the EU's executive Commission, said Friday.

Champions of the mechanism argue that it is necessary to protect taxpayers in economically strong countries like Germany from having to pay for the profligacy of 'peripheral' countries like Greece or Portugal.

Finance ministers of the 27 EU nations will now begin working out details of the new mechanism, including how much money eurozone nations are willing to chip in and when exactly private creditors would be involved.

But analysts warned that the new mechanism didn't address the region's existing debt woes.

"The new ESM should safeguard the eurozone's financial stability in the future," ING economist Carsten Brzeski said in a note. "However, it is to some extent window-dressing as it does not solve the current crisis. European leaders failed to address the issue of debt sustainability and possible insolvency problems prior to 2013."

Many economists warn that anemic or nonexistent economic growth, paired with anxiety about the health of the banks and surging borrowing costs, will make it difficult for countries like Greece, Ireland, Portugal or possibly much larger Spain to pay off their debts.

Those concerns were echoed in Moody's warning over Ireland's debt Friday. The rating agency dropped Ireland's rating to Baa1 from Aa2, citing losses from Ireland's banking sector, which has already received a euro45 billion capital injection from the government following a bruising real estate crash.

Moody's also kept its negative outlook for Ireland, meaning it could lower its creditworthiness further. The agency noted increased uncertainty in the economic outlook and a drop in fiscal strength.

The yield on Irish 10-year bonds rose Friday morning to 8.4 percent from 8.23 percent at the open. Although the bailout means Dublin won't have to borrow money on the open market in the coming years, higher yields indicate investor concern over a country's ability to repay its existing bonds.

On Thursday, Moody's already warned that "a multi-notch downgrade" of Greece's bonds was possible, since the country's debt turned out to be even bigger than expected. Greece was only saved from default in May by a euro110 billion rescue loan from other eurozone nations and the IMF.

The rating agency warned that support for the struggling nation might be less strong in the future than it had previously assumed. The government in Athens is facing growing discontent from its citizens. A general strike escalated into violence Wednesday, as unions and other demonstrators protested salary cuts and weakened collective bargaining powers.

Spain -- the eurozone economy many view as too big to bail out -- had to pay significantly higher interest rates to borrow euro2.4 billion ($3.21 billion) from bond markets Thursday, after it received a similar warning Wednesday.

A plan by Luxembourg's Juncker to introduce pan-European bonds to stabilize funding costs for weaker euro members found no takers Thursday given strong opposition from Germany.

Juncker said Friday that he didn't expect the issue to "be back on the table in the near future."

German Chancellor Angela Merkel meanwhile said that one answer to the crisis might be for the eurozone to seeks closer economic cooperation than governments have achieved so far.

"It is important that we don't just have stable budgets, stable finances, solid budgets, but it is equally important that we develop a common economic policy," Merkel said. However, she warned that closer economic integration will be "a long process."

[Associated Press]

Carlo Piovano in London contributed to this report.

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