European Union governments set tougher rules on budget deficitsin the latest draft of a planned fiscal treaty, bowing to someobjections raised by the European Central Bank.

The blueprint, to be discussed on Jan. 23 by EU financeministers, will require a centralized “correction mechanism” to betriggered “automatically” in cases of “significant” deviations froma target structural deficit of 0.5 percent of gross domesticproduct, according to the draft dated Jan. 19 obtained by BloombergNews.

The pact also empowers the European Commission to set deadlinesfor budgetary convergence. It gives the European Court of Justicethe power to fine countries whose balanced-budget laws don't passmuster, while stopping short of the ECB's request that the courtmore broadly enforce the budget rules.

The latest draft is a return to German Chancellor AngelaMerkel's drive to put stiffer rules on deficit control at the heartof efforts to combat the debt crisis. It also does more to heed ECBPresident Mario Draghi's warning that governments must followthrough on their “breakthrough” commitment to restore credibilityto public finances in the 17-nation euro area.

“It is now important to swiftly implement all of those decisionsto put the euro-area economy back on course,” Draghi said at anevent in Abu Dhabi yesterday.

The finance ministers on Jan. 23 will also discuss a separatedraft accord on Europe's planned permanent rescue fund that watersdown earlier provisions on debt restructurings. The proposedagreement still calls for clauses in bond contracts that wouldprevent small clusters of investors from blocking a restructuring,while deeming writeoffs “exceptional” and subject to InternationalMonetary Fund standards, according to a draft text.

Also on the agenda is a second financing package for Greece,which faces a 14.5 billion-euro ($18.8 billion) bond payment onMarch 20. Key to the new bailout package is a debt- swap dealbetween Greek officials and private creditors, who are continuingnegotiations today in Athens.

European stocks dropped from a five-month high and the euroweakened as Greek Prime Minister Lucas Papademos and FinanceMinister Evangelos Venizelos resumed the talks on a debt swap withInstitute of International Finance Managing Director CharlesDallara. The Stoxx Europe 600 Index declined 0.4 percent at 2:03p.m. in Brussels. The euro was down 0.4 percent against the dollar,trading at $1.2911.

'Substantial Changes'

ECB Executive Board member Joerg Asmussen on Jan. 12 requested“substantial changes” to the fiscal-treaty draft, saying themeasure should include “ambitious and binding calendars” formeeting new budget goals, as well as an automatic correctionmechanism. These changes are reflected in the new draft.

The treaty will enshrine tougher sanctions, which are already ineffect, at the constitutional level. It will make it easier topenalize high-deficit states and require each country to enactbalanced-budget amendments.

An ECB spokesman reached late yesterday declined to comment.Martin Kotthaus, chief spokesman for the German Finance Ministry,declined to comment on the pact when contacted by telephone inBerlin.

Asmussen also sought to give the Court of Justice an “effectiveenforcement of all elements” of the balanced-budget rules. And hecalled for limiting “escape clauses” to natural catastrophes and“serious” emergencies beyond the control of nationalgovernments.

The new treaty is tougher on both elements without adopting thefull range of the ECB recommendations.

It says the court could impose a lump sum penalty of up to 0.1percent of a country's gross domestic product, to be paid into theeuro area's permanent rescue fund, on countries whosebudget-balancing provisions are questioned.

The draft also says countries could avoid penalties if they face“exceptional circumstances” such as severe economic downturns or an“unusual event” that has a major impact on the affectedgovernment's financial position, according to the draft — a widerrange of exceptions than the ECB sought.

The document says the treaty will enter into force after 12members of the 17-country euro zone have ratified it. It also saysnecessary steps to implement the treaty changes shall be taken“within five years at most” after the treaty takes effect.

“We are pleased to see recent clarifications to thisinternational agreement,” Pia Ahrenkilde-Hansen, a spokeswoman forthe European Commission, said today in Brussels. “The work is goingin the right direction.”

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