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Draghi dials R for Reform. Line is busy

By Paul Carrel

FRANKFURT (Reuters) - Two years ago, euro zone government leaders hung on Mario Draghi's every word. Now the European Central Bank chief is struggling to get through to them. What has happened to 'Super Mario's' mojo?

For financial markets, Draghi's words still count. But therein lies a problem - his promise in 2012 to do "whatever it takes" to save the euro has reassured investors and driven down government borrowing costs to near record lows.

Euro zone governments, however, seem to have forgotten the caveat.

Draghi delivered his famous "whatever it takes" speech, and backed it up with a plan to buy "unlimited" amounts of bonds issued by stricken euro members - but only after governments agreed to his call for a "fiscal compact" on tougher budget discipline.

Now he is trying to cajole governments into agreeing a common approach to reforming their economies - a drive he sees as necessary to allow the stagnant euro zone to grow with verve.

"The essential cohesion of the (European) Union depends on it," Draghi said in July, repeating the plea on Aug. 7.

He is having a hard time selling the message.

Like a groom dieting for his wedding day, many euro zone countries shaped up to gain entry to the euro zone, only to let themselves go once that big day was behind them.

With their borrowing costs now low thanks to market reaction to Draghi's bond-buy offer, governments feel less pressure than at the height of the euro zone crisis to give him what he wants.

Draghi is seeking "common governance over structural reforms" - or a coordinated push to shape up by, for example, liberalizing labor markets.

Passing structural reforms is a tricky business at the best of times. But doing so under the banner of closer European cooperation is trickier still after voters' noisy 'no' to deeper EU integration at European parliamentary elections in May.

There are also vested interests to contend with. France's new economy minister ran into trouble with trade unions on Thursday for suggesting companies be allowed exemptions to the French 35-hour week.

"All these structural reforms involve challenging and defeating lobbies. They're small, but they're powerful - they have big voices," said Richard Portes, professor of economics at London Business School.

Sharon Bowles, who worked with Draghi as chairwoman of the European Parliament's Economic and Monetary Affairs Committee until July, said his push for governments to coordinate reforms and "to learn to govern together" was too much too soon.

"But I think he's got to keep pushing so that there is no slip back," she added.

CHANGE OF TACK

The experience of the euro zone crisis has shown that only when faced with the prospect of 'divorce' - or the currency union breaking up - do governments get serious about budget tightening and reform.

In Italian Prime Minister Matteo Renzi, Draghi faces a young man in 'dash-for-growth' mode who wants to reframe the debate.

Renzi holds the rotating EU presidency for the second half of this year and has led calls to move from austerity to looser European budget rules.

Draghi has cut him some slack. After months of pressing governments - principally France and Italy - to reform with little effect, the ECB president has changed tack.

Speaking at the annual conference of central bankers in Jackson Hole, Wyoming, on Aug. 22, Draghi said it would be "helpful for the overall stance of policy" if fiscal policy could play a greater role alongside the ECB's monetary policy, adding: "and I believe there is scope for this".

Translated from opaque central banker-speak, the comments indicate that having cut ECB interest rates to record lows and injected money into the economy to support a recovery, Draghi is now also ready to back fiscal stimulus over austerity.

Fiscal stimulus could boost growth, facilitating reform.

"It's much easier to introduce these (structural) reforms, to get people to accept these changes, if you have growth," said Portes. "And at the moment it's really tough, and everybody is out there trying to defend their special interests."

In effect, Draghi extended a thinly veiled invitation to those countries with the room - such as Germany - to pursue a more expansionary fiscal policy as part of a three-pronged policy approach including ECB stimulus and structural reforms.

Sarah Hewin, head of research for Europe at Standard Chartered, said Draghi was in a tough position because "there is very little leverage to accelerate this reform process."

BARGAINING POWER

Draghi is not having much luck with his reforms push - yet.

German Finance Minister Wolfgang Schaeuble has insisted the ECB president was "over-interpreted" in suggesting that fiscal policy could play a greater role in promoting growth.

In France, President Francois Hollande has reshuffled his government to boost his reform agenda but is struggling to galvanize his Socialists behind the plan. He also complains about the euro's strength, pressing the ECB to do more.

In Italy, Renzi has yet to deliver break-through reforms, though he has made many promises and taken some small steps.

Draghi has one trump card: quantitative easing (QE) - essentially printing money to buy assets.

The ECB is preparing other stimulus measures, but markets have factored those in. It is the possibility of QE that excites them, and some governments - even if its merits are disputed.

Departing from his Jackson Hole speech text, Draghi noted "significant declines at all horizons" in inflation expectations - a hint he is concerned, and may act. At 0.3 percent in August, euro zone inflation is far below the ECB's target of just under 2 percent.

The ECB is not ready for QE yet, but signs of serious progress on reforms in France and Italy could smooth the way.

"It may be hard to get a consensus within the (ECB Governing) Council to launch QE if the politicians are seen to be dragging their feet on reforms," said RBS economist Richard Barwell.

"But with the bond market no longer threatening to tear the (euro zone) marriage apart and a growing consensus that the ECB will be forced to launch QE, Draghi is playing with a much weaker hand now. Politicians may be willing to call his bluff."

(Writing by Paul Carrel Editing by Jeremy Gaunt)

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