EU leaders agree tougher budget scrutiny

European leaders agreed on Thursday to strengthen the eurozone’s economic governance by tightening surveillance of national budgets, paying more attention to debt levels and developing a scoreboard for assessing business competitiveness.

According to a draft summit communiqué, made available to the Financial Times, leaders of the 27-nation European Union also threw their weight behind tougher regulation of financial markets, including new measures on credit default swaps and “naked short selling”.

Credit default swaps, a form of insurance against debt default, and naked short selling, a transaction in which an investor sells a stock that he does not own but can borrow, have been a target for the wrath of European politicians this year as the sovereign debt crisis threatened the eurozone’s stability.

The one-day EU summit opened against a background of rising tensions in the European banking system and government bond market, little more than a month after the EU joined forces with the International Monetary Fund and rescued Greece with a €110 billion ($135 billion) aid plan.

The draft communiqué made no mention of stress tests on European banks, but diplomats said the leaders were likely to discuss proposals, supported by France, Germany and Spain, to publish the results of such tests as a way of calming market fears about the financial health of European banks.

“The EU has met the worldwide financial crisis with united resolve and has done what was necessary to safeguard the stability of the economic and monetary union,” the EU statement said.

But it added: “The crisis has revealed clear weaknesses in our economic governance, in particular as regards budgetary and broader macroeconomic surveillance. Reinforcing economic policy co-ordination therefore constitutes a crucial and urgent priority.”

The leaders agreed to strengthen the stability and growth pact — the EU’s fiscal rulebook — by considering “possible sanctions or incentives” to punish or reward countries applying the bloc’s budgetary rules.

However, they did not go so far as to support automatic fines or other, non-financial penalties, such as suspending a country’s EU voting rights.

Such ideas form part of the debate about European economic governance, but it will not be clear whether they enjoy general support until October, when Herman Van Rompuy, the EU’s president, is due to present his final report on the subject to the bloc’s leaders.

By common consent, one of the eurozone’s fundamental weaknesses is that the stability pact lacks enforcement mechanisms strong enough to compel countries to abide by the fiscal rules.

The EU leaders promised in their communiqué to give “a much more prominent role to debt levels and sustainability”, rather than budget deficits alone, when assessing the public finances of member-states.

This language appeared to amount to a victory for Italy, in that the reference to “debt levels” could be taken to mean not just public debt but public and private debt combined.

Italy, which has a public debt of more than 115 percent of gross domestic product, but which has relatively low private debt, wanted a broad definition of debt in order to avoid being placed in a category of “sinners” at risk of punishment.

The EU leaders announced that they planned to set up a scoreboard for assessing the competitiveness of member-states and allowing the early detection of dangerous trends, such as excessive current account deficits.

The leaders also expressed support in principle for a levy on banks to ensure that they contributed to the cost of overcoming financial crises. However, disagreements among member-states about how to apply the levy meant that the leaders confined themselves to asking the European Commission to report back to them in October.