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RPT-INTERVIEW-Europe needs market pressure to get economics right -Eurogroup head

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* Eurogroup chairman backs idea of debt restructuring mechanism

* EU budget rules becoming neglected, a matter of concern

* Commission's rule enforcement can be discussed, not taken away

WASHINGTON, Oct 14 (Reuters) - Euro zone governments need to feel market pressure to set the right economic policy, the chairman of euro zone finance ministers Jeroen Dijsselbloem said, backing an idea of creating a sovereign debt restructuring mechanism in the euro zone.

In an interview with Reuters on Saturday, Dijsselbloem said however, that such a mechanism should not be automatic, but only one of the options.

"We need the help of market incentives, market pricing of risks to get the economics right in Europe," Dijsselbloem said on the sidelines of the International Monetary Fund's autumn meetings in Washington.

"If the markets are not helping, not discriminating between risks, then all the pressure needs to come from European institutions and rules," he said.

Yet the budget rules, contained mainly in the Stability and Growth Pact that sets limits on government borrowing in European Union countries, have become very complex and many euro zone finance ministers believe that the European Commission, which under EU law is supposed to enforce them, is too political.

Germany even believes that the euro zone bailout fund ESM, owned by euro zone governments and in which Germany has the biggest stake, could gradually be given a bigger role in monitoring compliance with the rules.

COMMISSION CAN'T BE REPLACED

But Dijsselbloem said being unhappy with rule enforcement should not mean trying to replace the Commission in its duties.

"If we are not happy with the way this Commission is performing that task, then let's debate that... but let's not say that from now on we take that away from the Commission," he said.

He said he worried fiscal rules would over time be neglected by countries "because they feel that in the end, the Commission will always give them room for exceptions. And this is already happening a little with the Eurogroup. It is a matter of concern."

Before the euro zone sovereign debt crisis in 2010, markets did not differentiate strongly between debt issued by different governments in the euro zone, believing that in the end all such bonds represented general euro zone risk, which was very low.

This allowed some countries, which broke EU fiscal rules, to borrow more than their economy could repay, triggering a crisis that threatened the very existence of the single currency.

With all euro zone economies growing again, and unemployment and deficit levels falling, the euro zone is now considering how to integrate more deeply to prevent another crisis and make the single currency area work better.

The idea of a mechanism of sovereign debt restructuring could help turn up market scrutiny on governments who do not want to play by the rules.

"If there is no outside pressure from markets telling governments 'look you need to shape up' - it is going to be very difficult," Dijsselbloem said.

DEBT RESTRUCTURING MECHANISM TO HELP APPLY MARKET PRESSURE

Germany would like a mechanism mandating that a government seeking help from the euro zone bailout fund would automatically have to extend the maturities of its bonds and, if needed for debt sustainability, also restructure its debt.

Dijsselbloem said that might not be the right approach.

"If you say that if a country comes to the ESM for support there will always be sovereign debt restructuring, it will scare investors away from that country," he said.

He said the solution might be to make clear that "we have this instrument in our basket" but that it would not be used in every situation. "Because that may not always be the case," he said.

Other ways to bring market pressure to bear would be through changing the risk weighting on sovereign bonds or through introducing caps on the concentration of sovereign bonds in banks' portfolios, he said.

Separately, the euro zone bailout fund, which Germany would like to see transformed into a European Monetary Fund, similar to the International Monetary Fund, could cooperate with the Commission in preparing reviews, like the IMF regularly does for its members, the so-called Article IV reports.

"There can be practical solutions in which the Commission and the ESM jointly put out the sort of Article 4 reports on the macroeconomic situation in countries," Dijsselbloem said.

The ESM's role would grow even more in cases where a government became involved with it in any way, even to get a precautionary credit line.

"In the management of programmes, maybe initially the Commission would need to be the one to sign them off ...but in the development, design, implementation, monitoring, the ESM could do the work. Partly on behalf of the Commission and partly on behalf of the Eurogroup," he said. (Reporting By Jan Strupczewski; Editing by Andrea Ricci)