Ending months of intense debate, EU governments on Monday agreed on tougher budget rules for euro-zone nations that can trigger fines for countries racking up big deficits and debts like the ones that have eroded confidence in the euro.
The complex deal provides for penalties to keep European governments away from unbridled spending, but backed off earlier proposals to make them almost automatic if governments breach EU limits.
Herman van Rompuy, the EU president who led the debate among EU governments, spoke of "a great step forward in economic governance" and "the biggest reform" since the euro came into circulation in 2002.
Meeting in Luxembourg, the 16 eurozone finance ministers backed an agreement under which countries deemed to be violating the euro's public deficit and debt ceilings _ of 3 percent and 60 percent of GDP, respectively _ risk big fines.
But at France's insistence these will not be automatic. To the dismay of such euro-hardliners as the Netherlands, Sweden and Slovakia, penalties can only be imposed if a majority of EU governments first vote that a country has indeed breached EU rules.
In a two-step process, a majority of EU governments first needs to decide whether a country is either on the path to violating or has already broken deficit limits. Once that decison has been taken, the European Commission, the EU's executive, can impose sanctions, which in turn can only be stopped by a majority of governments.
The eurozone's deficit and debt targets remain unchanged, officials said.
Future sanctions, they added, could start by forcing wayward eurozone members to set aside interest-bearing deposits, worth up to 0.2 percent of GDP. In a later stage, they may be denied the interest before the principle itself is taken away.
In extreme cases, EU funds, such as structural subsidies, may be withheld from overspenders.
Under the new rules, high deficit euro members may get a six-month deadline to embrace austerity. The new rules are intended to strengthen an earlier set that proved toothless; a number of countries, including France and Germany, have broken the rules but no eurozone member has ever been fined.
The Luxembourg deal came as the leaders of France and Germany _ meeting in Deauville, France, hundreds of miles away _ agreed on a related measure, a permanent crisis insolvency mechanism, involving sacrifices by private creditors, for countries that drown in debt.
That would require changing the EU treaty, a step bound to take several years.
French President Nicolas Sarkozy and German Chancellor Angela Merkel said in a joint statement Europe must "take appropriate coordinated measures to safeguard the financial stability of the Euro area as a whole."
Ballooning deficits and debts, notably in Greece, Portugal and Spain this year, have eroded confidence in the euro and forced the EU to put up more than 100 billion euros (dollars) to bail out Greece.
Speaking in Deauville, Sarkozy said the new rules will enable the EU "to decide ... to take preventive sanctions if the government does not sufficiently reduce its deficit."
The proposed insolvency mechanism was high on the wish list of Germany which has long feared that its taxpayers will end up funding the excesses of less disciplined EU states through bailouts.
In parallel to the new budget rules, the EU head office had already been given new monitoring powers of national budgets to ensure their spending doesn't hurt the EU's economic goals.
The euro currency is in use now in 16 EU nations _ Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain _ with a total population of almost 329 million people.
The beefed up budget rules will likely be endorsed by the 27 EU leaders in Brussels next week. They must also be approved by the European Parliament and are to take effect in 2011.