Don't risk market confidence by bending budget rules - EU economy czar

By Jan Strupczewski and Paul Taylor

BRUSSELS (Reuters) - Euro zone countries must beware of bending budget rules in the quest for economic growth, the EU's new economics czar said on Thursday, suggesting some proposals from France and Italy sought too much leeway.

Former Finnish Prime Minister Jyrki Katainen, likely to take office on Friday after being confirmed by the European Parliament as economic and monetary affairs commissioner until November, told Reuters that tumbling government borrowing costs could spike again if investors felt reforms were faltering or fiscal discipline was fading.

"In my mind, the main issue at present is to secure stability in the euro zone," he said in an interview.

He politely dismissed calls by Rome and Paris to exempt certain public investments from the calculation of budget deficits, saying it was very difficult to set an objective rule defining what spending was growth-friendly.

"To me it sounds like a trick," he said.

A sudden alarm in Portugal last week over the health of Banco Espirito Santo , with ripple effects in other bailed-out peripheral euro zone countries, was a reminder of the risks.

"(This) shows that we are still in a very fragile situation and we should not do anything that would endanger the position of the most vulnerable countries," Katainen said.

Countries such as Spain and Portugal, which had made huge sacrifices to regain market confidence, had asked him to ensure Brussels did not allow other countries to send any messages that could upset markets and raise their borrowing costs, he said.

European Union leaders agreed in June that budget rules should not be changed again after major revisions in 2005, 2011 and 2013, but that governments should fully use the leeway already built into the Stability and Growth Pact agreed in the run-up to the euro currency union.

The EU will review its fiscal rules at the end of this year to see if they can be made simpler and used more efficiently to encourage growth and jobs after years of tax rises and spending cuts.

Most euro zone governments breach the rule limiting total debt to 60 percent of gross domestic product (GDP) and struggle with the annual budget deficit limit of 3 percent of GDP.

Katainen said governments that wanted to increase public investment to kick-start sluggish growth should do so by "prioritisation" - code for cutting spending elsewhere - rather than by increasing their budget deficit and debt.

In a clear response to pressure from Italy and France for looser enforcement of the European Union's 3 percent limit on budget deficits, Katainen said governments should ask themselves why their economies were growing more slowly than others despite "pouring in more public money".

SACRIFICES

A loss of competitiveness or high public debt could not be solved by increasing borrowing, he said.

He praised Italy's budget consolidation and acknowledged "reform fatigue". But, noting the deep social cost of mass unemployment especially among the young in southern Europe, Katainen said the sacrifices would have been in vain if reforms were not followed through to completion.

"If we send a message that we are too tired of putting our house in order and we allow public debt to grow again, that reforms are too difficult politically ... it might lead to spreads growing again," he said, referring to the big gap in borrowing costs between weaker and stronger euro zone economies that opened up during the euro debt crisis.

"The work that has been done in the most vulnerable countries would be lost."

Katainen also said it was vital to apply EU rules equally to all member states, in an apparent reference to complaints about leniency for France, still off course to cut its deficit to within EU limits even after being granted a two-year respite.

"I come back to the message I got from countries that are very worried about stability, like Portugal and Spain," he said. "The world is not so simple that the Commission could do a political deal with some countries without taking care of the implications for other European countries."

(Writing by Paul Taylor; Editing by Ruth Pitchford)