(Adds detail, background)
LUXEMBOURG, Oct 9 (Reuters) - The euro zone bailout fund should play a role in monitoring government fiscal policies and their compliance with EU budget rules while managing automatic debt restructuring of bailed-out governments, a German paper on euro zone reforms said.
The document, prepared for discussions of euro zone finance ministers on Monday in Luxembourg, lays out the views of Berlin in a debate on the future of the European Stability Mechanism (ESM) - the lender of last resort to euro zone governments - on how to turn it into a European Monetary Fund.
Unlike the International Monetary Fund, which is also the lender of last resort for governments around the world, the ESM does not have policy-monitoring powers before a government is cut off from market borrowing and asks for a rescue programme.
"It is therefore important to expand the ESM's radar and give it a stronger role in terms of monitoring country risks," the German paper, seen by Reuters, said.
"The aim is to identify, in cooperation with other institutions, stability risks for and in Eurozone member states more effectively and at an earlier stage than in the past, and to monitor these risks so that they can be reduced by the affected countries themselves.
"The IMF's Article IV consultations could serve as a blueprint for this new role," it said.
But under EU treaties this role is reserved for the European Commission, which polices EU budget rules - the Stability and Growth Pact. It enforces limits on government borrowing and implements disciplinary steps for those who break them.
"Fiscal responsibilities and fiscal control belong together, whatever it takes," the paper said. "The ESM could gradually be given a stronger, neutral role with regard to the monitoring of the Stability and Growth Pact," it said.
The paper further said EU budget rules enforced by the Commission have become too complex and less predictable.
"This is why we have to develop these rules further, with the debt rule at least on an equal footing with the deficit rule. As long as national debt is on a declining path, national deficits could be treated flexibly," the paper said.
To better enforce fiscal discipline and ensure fair burden sharing between the ESM and private creditors, Germany proposes setting up a sovereign debt restructuring mechanism that would be known to investors before they buy government bonds.
If a government were to ask for a bailout, the maturities of its bonds would be automatically extended and, if debt sustainability required that, there would be a comprehensive debt restructuring.
Among the expanded tasks of the ESM, euro zone officials often mention becoming the financial backstop for the Single Resolution Fund for banks. But the German paper said this could only happen if proposals on reducing risks of failure of banks in the euro zone were stepped up.
The paper ruled out the ESM's role as a backstop for the yet-to-be-created European Deposit Insurance Scheme (EDIS) or a potential euro zone budget. It said the euro zone did not need a special budget to provide incentives for government to implement unpopular structural reforms.
"In this respect we should examine whether future euro members contributions to the EU budget could be better linked with structural reforms in the euro area, based on the Commission's country specific recommendations," it said.
It also said that ideas for deeper euro zone integration like a euro zone budget or an unemployment insurance scheme were economically not necessary in a stable monetary union.
It argued that the euro zone already had well developed welfare policies which worked as stabilisers during economic downturns.
Finally, the German paper dismissed Commission ideas of creating European Safe Bond, or a Sovereign Bond Back Security which the EU executive sees as a way to help differentiate risk in bank bond portfolios, now often dominated by paper from only the national sovereign.
"There is no demand in the market. We must be able to create real stability through reforms, not through complex and expensive financial engineering," the paper said. (Reporting by Jan Strupczewski; editing by Mark Heinrich)