Major Setback for Economic Integration Plan

Europe's efforts to seal a new pact to deepen economic integration was dealt a setback even before it comes to life after Standard & Poor's (S&P) warned that the treaty may lead to self-defeating austerity.

European Union leaders agreed after a tense summit earlier to write a new pact to toughen budget discipline across the bloc, with Germany leading the charge for stricter policing of spending after years of toothless oversight.

The aim of the pact is to convince the markets that the euro zone can prevent a new crisis like the one that has forced Greece, Ireland and Portugal to take bailouts and is driving Italy and Spain to the edge.

But after downgrading the credit score of nine of the euro zone's 17 states on Friday, including stripping France and Austria of their triple-A ratings, S&P voiced doubt about the effectiveness of the pact.

The new treaty, which EU leaders hope to sign by March, "has not produced a breakthrough of sufficient size and scope to fully address the euro zone's financial problems," it said.

The pact is based "on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the euro zone," the agency said.

To S&P, the euro zone's problems "are as much a consequence of rising external imbalances and divergences in competitiveness between the euro zone's core and the so-called 'periphery'".

Negotiators this week reached an agreement in principle on the "fiscal compact," which demands that governments write into their constitutions a law requiring balanced budgets.

The pact would make sanctions against governments that violate budget rules more automatic, after most countries ignored for years EU rules limiting public deficits to three per cent of gross domestic product.

But S&P warned that "a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues."