* German ruling on bailouts, budget rules on Sept 12
* Constitutional Court seen giving qualified "yes"
* May demand more consultation, limited liability
By Stephen Brown
BERLIN, Sept 3 Germany's Constitutional Court
holds the fate of the euro in its hands when it rules next week
on whether a crucial euro zone financial rescue fund can go
A negative ruling, considered improbable by legal experts,
would cast the 17-nation European single currency area into
turmoil, spurring panic on bond markets by raising doubt over
any more rescues of debt-laden southern states.
But if, as expected, the court gives a green light on Sept.
12 to the euro zone's permanent bailout mechanism and a pact on
stricter budget discipline, it may add conditions that constrain
Berlin's power to pursue further European integration.
The court based in Karlsruhe in western Germany, one of the
country's most trusted institutions, is unlikely to let
Chancellor Angela Merkel completely off the hook.
Few experts expect the eight red-robed judges to reject the
European Stability Mechanism (ESM)and fiscal pact outright, not
least because of the devastating impact on financial markets.
"If they were to surprise us by striking down Germany's
participation, I would think it'd be an utter bloodbath in
markets," UniCredit global chief economist Erik Nielsen said.
But the sages may well demand more parliamentary
consultation before Germany agrees to any further European
integration, or signal that the process has gone as far as can
be permitted without rewriting Germany's Basic Law.
"I don't think the court will block the ESM or the fiscal
pact, so European integration of the euro will not come to an
end on Sept. 12," said Franz Mayer, a professor of European
Union and constitutional law at Germany's Bielefeld University.
"But it is unlikely there will just be one paragraph saying
'no problem at all, just go ahead'. As in the past, it will be
foggy, open to interpretation and all parties involved will say
'We won'," Mayer told Reuters.
The ESM was meant to succeed the existing temporary European
Financial Stability Facility (EFSF) from July and erect a 700
billion-euro firewall to prevent the euro zone's sovereign debt
crisis from spreading further.
But Karlsruhe threw a spanner in the works by deciding in
mid-July to take two months to look into complaints that the ESM
and the fiscal pact that gives EU institutions intrusive powers
to enforce the currency area's budget rules violate the German
That left the fate of the new rescue fund in limbo. Without
ratification by the biggest economy it cannot go into force.
On Sept. 12 the court's Second Senate will rule on requests
for an injunction from over 12,000 plaintiffs, who include
eurosceptics from academia and Merkel's own coalition as well as
the hardline Left Party.
They essentially argue that these treaties undermine German
lawmakers' constitutional right to decide on the budget and
expose Germany to potentially unlimited financial liability for
the ESM risks.
Rulings on the EU's Lisbon Treaty in 2009 and on the Greek
loans and the EFSF in 2010 earned the court a reputation as a
thorn in the side of the euro for insisting on the Bundestag's
(lower house of parliament) rights as a condition for approval.
"For Germans this is nothing new, every major decision on
European integration is contested domestically so we are pretty
much used to it and not overly worried," said economist Klaus
Deutsch of Deutsche Bank.
"Given the fact that they decided positively on the EFSF,
I'd be surprised if they came out clearly against the
constitutionality of the ESM," he added.
SOFT AND HARD OPTIONS
Set up in 1951 to avoid a return to Nazi tyranny, the court
has a history of testing the patience of chancellors such as
founding father Konrad Adenauer, who called it "the dictator of
The ruling comes amid frantic diplomacy over proposed action
by euro zone governments and the European Central Bank (ECB) to
cap Spanish and Italian borrowing costs, which is conditional on
the ESM being deployed.
Merkel says it is "of the utmost importance" that the court
approve the ESM. The worst-case scenario for euro zone leaders
would be Karlsruhe rejecting it, leaving them in the short term
with only 150 billion euros left in the EFSF.
German ECB board member Joerg Asmussen has said a 'No' from
the court would just require "changes to the construction" of
the ESM. But Morgan Stanley economists, rating the chances of a
'No' verdict as high as 40 percent, said one impact of this
would be to permit "only cosmetic" ECB bond-buying via the EFSF.
"We believe that markets are not priced appropriately for
the downside tail risk of a possible 'no' verdict," the
investment bank said in a note.
Still, the most likely scenario is that the court allows
Germany to ratify the ESM and fiscal pact - but with qualifying
comments that could range from mere formalities to fundamental
observations about European integration that could reverberate
for years to come.
The "soft" options include reiterating the need to consult
lawmakers, splitting hairs about where the ESM treaty belongs in
the constitution, or tinkering with details of the fiscal pact.
It could slow down the ESM by insisting that the upper house
(Bundesrat), representing the federal states, also vote on new
rescue requests or on new powers such as granting the ESM a
Constitutional experts have also speculated that the court
could demand that a reservation be attached when President
Joachim Gauck signs Germany's ESM ratification.
This would address concerns about exposure to the ESM being
open-ended - for example, if other euro zone states are unable
to pay their share, or if there is an attempt to raise the
maximum capital - by setting in stone the interpretation of
The court could even force an unprecedented referendum on
deeper EU integration by rejecting the treaties outright or by
stating that no more sovereignty can be transferred to European
authorities or courts under the current German constitution.
"A change of the German constitution would be a big
game-changer on the future of the euro," wrote Morgan Stanley.
This would take Germany into uncharted territory. The
constitution does not permit nationwide plebiscites, which got a
bad name in the Weimar Republic and under the Nazis. Neither is
there any guarantee that the public, let alone the increasingly
eurosceptic media, would back deeper political and fiscal union.
"You can imagine that if there were an aggressive ruling,
meaning at least a referendum and possibly much more, the result
could be a huge economic depression unseen in Germany or Europe
since World War Two," said Humboldt University's Matthias Kumm.
But the law professor believes the judges, especially
48-year-old court President Andreas Vosskuhle, are
"finely-tuned" enough politically to avoid such a bombshell.
While Vosskuhle and court rapporteur Peter Huber, who drafts
the ruling, are known to lean towards the idea of a referendum
on Europe, as does Finance Minister Wolfgang Schaeuble, the
judges will not want to sign away their powers or complicate the
2013 election, when Merkel will seek a third term in office.
But the referendum debate will not go away. Opinion polls
suggest seven out of 10 Germans would like to have a direct say
in how much more sovereign power - especially regarding how
their taxes are spent - should be surrendered to Brussels.
Katinka Barysch at the Centre for European Reform said this
debate "suits both the opposition and government", giving the
Social Democrats an easy platform and enabling Merkel to "put
off hard decisions until after the 2013 election".