Belgium tries to resolve budget, political troubles

BRUSSELS -- In the midst of Europe's worst economic crisis in generations, Belgium has been without a fully functioning government for more than 530 days .

Squabbling Belgian politicians were finally stung into action after Standard & Poor's announcement late Friday that it cut the country's credit rating from AA+ to AA, the first cut in more than a decade.

With interest on Belgian 10-year bonds already above 5%, the ratings cut risked pushing government borrowing costs to unsustainable levels — and making Belgium the next domino to fall in the eurozone's ever-widening debt crisis. In response, political parties agreed over the weekend on a draft budget to cut the deficit to 2.8% of gross domestic product next year through an 11.3 billion euro ($15 billion) package of savings and new taxes.

An economic collapse in this nation of 10 million could reverberate beyond its borders: Belgium is a core member of the eurozone and one of the founders of the EU, and its capital, Brussels, is host to the bloc's headquarters. Belgian banks and the wider economy are also closely connected to France, itself under mounting pressure from the markets.

In a sign of growing European concern, the top finance official at the EU's head office appealed last week for Belgium to get its act together with budget measures to control public debt, which is set to rise to 97.2% of gross domestic product in 2012.

"I trust that Belgium as a founding member state of the European Union, as a very committed euro-area member state, will carry out its responsibility to meet these fiscal targets and decide on the other reforms, for the sake of Belgium and its citizens, as well as for the sake of Europe as a whole," Olli Rehn, the EU's economic and monetary affairs commissioner, told reporters.

To emphasize his point, Rehn is threatening to use new crisis powers granted to the European Commission to sanction Belgium — along with Cyprus, Malta, Poland and Hungary — if it doesn't produce a credible plan for controlling public finances by mid-December. Belgium could face fines of 700 million euros ($932 million).

Saturday's budget deal has raised hopes that a new government can be formed this week, ending the deadlock between French- and Dutch-speaking parties that has left the country under a caretaker government with limited powers since inconclusive elections on June 13, 2010.

"We've shown that Belgium is able to take very difficult decisions and to face up to any situation," said Elio di Rupo, the leader of the Socialist Party who led the negotiations and is expected to become the first prime minister from Belgium's minority French-speaking community since the 1970s. Labor unions have called a day of action on Friday against the measures, which include delaying retirement ages and cutting unemployment benefits, as well as taxes on higher incomes.

In a first market reaction, a 2 billion euro ($2.7 billion) Belgian bond issue on Monday was over-subscribed, but the state still had to pay 5.6% on its 10-year bond. That was down slightly from last week but still historically high.

Aside from the wider eurozone worries, Belgium's banking sector is also weighing heavily on investors' concerns. Last month, the government spent 4 billion euros ($5.3 billion) to nationalize parts of the ailing Dexia financial group and agreed to a 10-year guarantee to cover the Franco-Belgian group's funding needs to the tune of 54 billion euros ($72 billion). The French and Luxembourg governments took on Dexia liabilities for a further 36 billion euros ($48 billion).

The financial daily De Tijd estimates that crisis measures the Belgian state is now liable for total almost 130 billion euros ($173 billion) in financial sector guarantees, about a third of the country's GDP.

Such exposure has triggered fear that Belgium could be dragged into a situation such as Ireland's last year, in which government finances were ruptured by the effort to keep failed banks afloat, forcing Dublin to seek a bailout from the EU and the International Monetary Fund. On the other hand, failure to keep Dexia afloat could reverberate beyond Belgium's borders. The group holds assets of about 518 billion euros ($690 billion), more than Belgium's GDP.

"In a small country, when your banking sector gets into serious problems, it can simply kill public finances. That is similar to the Irish situation," says Carsten Brzeski, chief economist at the Brussels branch of financial group ING. "It's a Belgian Catch-22."

The Belgian budget deal is likely to be greeted with some relief by European finance ministers meeting in Brussels today and Wednesday.

Their talks are expected to focus on how to leverage the EU's 440 billion euro ($586 billion) European Financial Stability Facility. EU leaders announced plans in October to increase the clout of the bailout fund to 1 trillion euros ($1.3 trillion) to help protect bigger EU economies such as Spain or Italy from the fate of Greece, now reliant on EU and IMF loans.

However, many economists are urging the European Central Bank to act as a lender of last resort for governments and calling for the issuing of common bonds that would have the backing of the EU's strongest economies as the only measures that can hold the eurozone together.

German Chancellor Angela Merkel opposes both remedies. Instead, she wants strict new rules to impose fiscal discipline on all eurozone nations. Merkel will join EU leaders in Brussels Dec. 9 for a summit which is increasingly seen as make-or-break for the euro.