The current drive to cut government debt and spending in the euro zone could reduce the region's economic growth in the coming years, the International Monetary Fund said yesterday (21 July).
Crisis-hit EU countries have adopted highly unpopular austerity measures, which in the case of Greece sparked violent street protests (EurActiv 05/05/10).
As speculative attacks on the euro currency continued to rage, other countries soon followed suit. In May, Italy approved austerity measures expected to reduce the budget deficit by 24 billion euros over two years (EurActiv 25/05/10).
Previous EU presidency holder Spain managed to win approval for a 15-billion-euro austerity package on 27 May (EurActiv 28/05/10).
In June, Germany announced a package of budget cuts and taxes worth 80 billion euro aimed at bringing the structural deficit of Europe's biggest economy within EU limits by 2013.
Earlier, the UK, which is outside the euro zone, announced 6.2 billion pounds (7 billion euros) in spending cuts to try and reduce its deficit, which stands at 11.5% of GDP, almost four times the EU limit.
The IMF's European Department published a report on the euro zone after talks with the European Commission and the European Central Bank.
It warned that further economic problems could not be ruled out, said the euro's heavy slump since the start of the year had reduced it to roughly the right level, while record low 1% ECB interest rates should be kept in place to aid the recovery.
"Weakened confidence and the drag from fiscal adjustment - accelerated in some parts of the euro area - will be only partly offset by the recent depreciation of the euro, which is now broadly in line with fundamentals," the report said.
The euro zone was also at risk of suffering a credit crunch, with high-debt countries Greece, Italy, Portugal and Spain most in danger due the amount of people employed by small and medium-sized firms, who may struggle to borrow.
"Constrained bank loan supply could weigh heavily on the recovery of the euro-area economy," the report said.
Spending cuts by eurozone countries in a bid to rectify debt problems could also hit growth. While a rebound in confidence might soften the blow, on the whole private consumption was "not likely to contribute substantially to growth until late 2011".
"In countries where fiscal credibility is being questioned, front-loaded consolidation would inevitably dampen demand in the short run," it added.
Shock waves from the sovereign debt crisis were the biggest danger.
It warned that "a sharp weakening of growth in the second half of 2010 would occur" if the recent plunge in business confidence becomes entrenched, while "the nascent recovery, driven mainly by external demand, is likely to be slowed in the near term by market tensions related to sovereign risks".
More to be done to stabilise euro
There were also risks for the euro, which had plunged 16% on a trade-weighted basis since the start of the year at the report's data cut-off date of 1 July.
"If downside risks were to materialize the consequences could be severe, threatening the global recovery, with global financial conditions tightening sharply and the euro depreciating substantially."
Countries may also have to take more action to reduce debt.
"Additional efforts will be needed to stabilise debt dynamics over the long term," the report said.
It said IMF staff "agreed that the [ECB's] monetary policy stance can remain very supportive," and said it could revive plans to phase-out support measures when the time was right.
However, "tightening collateral requirements will be difficult and should wait until the euro area crisis is resolved".
"Beyond the near term, the collateral framework may need to be revisited to address concerns about the quality of the ECB balance sheet," it added.
(EurActiv with Reuters.)