* France wins more staggered budget sanctions process
* Germany secures support for review of EU treaties
* Dismay at rules being decided by Paris, Berlin
By Jan Strupczewski
LUXEMBOURG, Oct 19 (Reuters) - A last-minute Franco-German deal has watered down changes to European Union budget rules and means politicians may ultimately be able to prevent sanctions being imposed.
Germany had until Monday led a group of EU countries keen to see near-automatic penalties imposed on those breaking EU budget rules -- a move to prevent another Greek-style debt crisis.
But a deal struck between French President Nicolas Sarkozy and German Chancellor Angela Merkel at a summit in Deauville, France, trumped discussions among EU finance ministers in Luxembourg over the rules and means the new regime is likely to be softer than it might otherwise have been, euro zone sources said.
The big question is whether France and Germany have now compromised the credibility of the reworked budget rules, or whether there will be sufficient rigidity in the new system to prevent future crises and keep budget breakers in check.
That question will not be answered until the rules have to be enforced but EU finance ministers expressed reservations about whether the deal they ended up with was as strong as it could have been, and EU sources were concerned about a watering down.
"I'm a little bit surprised that we did not have the full 100 percent backing for fiscal discipline from Germany. We could have reached a little bit further," Swedish Finance Minister Anders Borg told reporters on Tuesday.
A senior euro zone source present during the talks was less diplomatic. "It was appalling -- the Germans were like a poodle of the French, they even prevented the smaller countries from having a go at France," the source said.
Publically, most finance ministers said they were pleased to have reached a deal, which will involve more immediate measures being taken against countries whose budget deficits exceed EU limits and who are not doing enough to bring the shortfall down.
But under the Franco-German deal, Paris has secured extra steps in the sanctions process which will give countries more political oversight and which could potentially stall the process, making it barely more strict than the current system.
Ministerial agreement to move forward with sanctions could now be stopped by a blocking minority, a lower threshold than originally proposed by the European Commission.
That would make it easier for large countries with bigger voting power, such as France or Germany, to do so than for smaller ones, raising the issue of equal treatment of euro zone members.
"There is agreement that only a majority of ministers can stop sanctions from being applied, but the problem is that the introduced changes mean we may never get to the stage where such a vote on sanctions would take place," one euro zone source said.
In exchange for supporting France, euro zone sources said Berlin had likely secured French support for changes to the EU treaty to be able to suspend the voting rights of euro zone countries that are in serious breach of euro zone rules and the creation of a permanent mechanism for crisis resolution.
But changes to the main EU law have to be ratified by all 27 EU member states to enter into force and are tough to enact.
"It is hard to imagine Portugal, Italy, Greece, Spain or Ireland agreeing to have voting rights suspended for countries that are in serious breach of EU budget rules," the first source said, referring to countries that already are in serious budgetary difficulties and well above EU limits.
MUDDIED PROCESS
One source attending the discussions decried what he saw as political meddling in a process that must be above politics if it is to seen as tough and unimpeachable by financial markets.
"Give politicians a crack in the rules and they will drive a truck through it," he said.
At the same time, the sources said the rule changes went broadly in the right direction and would result in a tougher set of sanctions than currently exist.
Monday's finance ministers' meeting put the finishing touches to a broad overhaul of the 27-nation bloc's fiscal rulebook, with focus on the 16 countries sharing the euro.
EU budget rules say that countries should seek a budget close to balance or in surplus by cutting their deficit by at least 0.5 percent of GDP a year, and must not have a deficit above 3 percent of GDP and debt above 60 percent of GDP.
Under the agreed new rules, the European Commission would issue a warning to a country that did not move towards a budget close to balance or in surplus.
But then, instead of waiting six months and moving directly to sanctions if the country ignored the warning, France pushed for and got the two extra voting stages.
Because sanctions, in the form of interest-bearing deposits, non-interest bearing deposits and finally fines, would gradually grow tougher only if there was agreement a country did not comply with the first set of recommendations, blocking the first decision could, in effect, stop the whole sanctions process.
"In an extreme case, this means that things could stay exactly the way they are now -- for example France could muster a blocking minority that would torpedo an agreement that Paris has not complied and then France could even see its deficit rise above 3 percent of GDP and sanctions would still not apply," the euro zone source said, referring to the budget deficit limit. (Reporting by Jan Strupczewski, editing by Luke Baker/Mike Peacock)