Brussels: Twenty-three European Union states agreed on Friday to set up a new treaty, giving up crucial powers over their own budgets in an attempt to overcome a crippling debt crisis.

Who’s plans to be in it?

French President Nicolas Sarkozy (L) talks with German Chancellor Angela Merkel (C) and European Commission president Jose Manuel Barroso (R). Photo: Reuters

Who’s not in it?

The UK gave a clear “no," while Hungary, Sweden and the Czech Republic left the door open to sign up at some point if their parliaments want them too.

Why did Europe need a new treaty?

For the past two years, the countries that share the euro have been rocked by a debt crisis that has recently threatened the survival of the currency. Germany and France in particular argued that only tough rules enshrined in a treaty would convince markets that all countries will be able to repay their debts and a similar crisis will never happen again.

How will that be achieved?

Debt brakes in national constitutions: All 23 countries commit to keep their deficits below 0.5% of economic output. That cap can be broken to counteract a recession or in other exceptional circumstances. The European Court of Justice will make sure all states’ debt brakes are effective. More automatic penalties for deficit sinners. In the past, governments often protected their partners from being punished. All states have to tell their partners in advance how much debt they plan to take on through bond sales.

What else did they decide?

The euro zone, together with other willing EU states, will give as much as €200 billion to the International Monetary Fund (IMF) to help it rescue troubled nations.

The euro zone’s permanent bailout fund, the European Stability Mechanism, will take over from the current rescue fund, the European Financial Stability Facility (EFSF), one year ahead of schedule, in July 2012. Unlike the EFSF, the ESM has paid-in capital, similar to a bank, and is therefore more credible on financial markets.

The ESM’s decision-making process was simplified in emergency situations, allowing struggling countries to get financial help if an 85% majority of capital holders agree. That is meant to stop small countries from blocking or slowing down urgent rescues, as has happened in the past.

The euro zone eased rules that have forced banks and other private investors to take losses when a country gets a bailout from the ESM. The previous push to inflict losses on bondholders has been blamed for exacerbating the crisis.

What did they fail to agree on?

Euro zone leaders did not decide to boost the overall firepower of their own bailout funds, which is currently limited to €500 billion. They promised to reconsider that cap in March, shortly before the ESM comes into force.

They did not agree to more intrusive powers for the European Commission over the fiscal policies of wayward states, as had been demanded by European Council president Herman Van Rompuy and some nations. Instead, they promised to “examine swiftly" much more lenient proposals from the Commission.

They did not allow the bailout funds to directly recapitalize failing banks. That could have prevented countries from taking on more debt when they have to bail out lenders.

Will it work?

Stock markets and the euro rose modestly in reaction to the deal, but many details remain to be worked out. Much will depend on whether the stricter fiscal rules can persuade the ECB to unleash massive funds to buy up euro zone bad debt.

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