EU Dials Back Austerity Amid Recession, Youth Unemployment

Photographer: Chris Ratcliffe/Bloomberg

Pedestrians pass graffiti between stores in Ljubljana, Slovenia, on May 9, 2013. Close

Pedestrians pass graffiti between stores in Ljubljana, Slovenia, on May 9, 2013.

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Photographer: Chris Ratcliffe/Bloomberg

Pedestrians pass graffiti between stores in Ljubljana, Slovenia, on May 9, 2013.

Recession-hit countries including France, Spain and Italy won greater budget freedom as the European Commission tried to stem the euro economy’s longest slump and bring down a 24 percent youth unemployment rate.

The commission eased up on the austerity policies championed by Germany in the wake of the debt crisis without proposing new spending programs for the 17-nation euro zone, set to be the world’s weakest economic link in 2013.

“Because of good progress made, we now have the space to slow down the pace of consolidation,” commission President Jose Barroso told reporters in Brussels today. “Member states should now intensify their efforts on structural reforms.”

A nonstop economic contraction since the fourth quarter of 2011 has given rise to fears of a Japan-style “lost decade” especially in the once-booming southern European countries blighted by the debt crisis.

A “small paradigm change” is in the works, Riccardo Barbieri, chief European economist at Mizuho International Plc, said in a note today. “The EU is now weakening its stance on austerity, while focusing more on broad reforms.”

The commission forecasts that the euro economy will shrink 0.4 percent this year, with declines of 4.2 percent in Greece, where the crisis started, and 8.7 percent in Cyprus, the latest country to fall back on emergency aid.

Debt Crisis

German-inspired European Union rules cap deficits at 3 percent of gross domestic product, a level breached by 11 euro countries last year. The commission today offered France two more years, until 2015, to reach that target. Spain (GDBR10) was granted two years, until 2016, and Slovenia two years, until 2015. Portugal got an extra year, until 2015. Even the fiscally strict Netherlands, a German ally in the debt-crisis response, was allowed an extra year, until 2014.

Pressure was relaxed on Italy, which was right at the limit last year, to further shrink the deficit. That gives new Prime Minister Enrico Letta more room to cut property, consumption and payroll taxes, with the twin goals of restarting the economy and keeping his shaky governing alliance in power.

Tax relief and the settlement of unpaid bills owed to companies leave the Italian government with “a very small safety margin,” EU Economic and Monetary Affairs Commissioner Olli Rehn said. He welcomed the “strong safeguards” that would kick in automatically to prevent Italy’s deficit from swelling back above the limit.

‘Effective Action’

Two countries were ordered to do more: Belgium, with a 3.9 percent deficit last year, has failed to take “effective action” and must hit the target in 2013, the commission said. It opened a disciplinary procedure against Malta, the euro zone’s smallest economy, for overstepping the limit.

The commission’s verdicts require an endorsement by national finance ministers. While Germany has signaled that it won’t seek to overturn the recommendations, the anti-austerity tilt has provoked criticism from Berlin in the runup to national elections in September.

“We won’t agree to a weakening of the budget rules,” Norbert Barthle, parliamentary budget spokesman for Chancellor Angela Merkel’s Christian Democratic Union, said May 27.

The commission tiptoed around the question of getting Germany to spur consumer spending, which would be one way of lifting the broader European economy. Noting that German take-home pay is on the rise, Rehn urged Merkel’s government to promote “the conditions that enable wage growth to support domestic demand.”

Youth Unemployment

After a Brussels summit last week, Merkel reassured her home audience that European governments aren’t throwing more cash at economic problems beyond a previously announced seven-year, 6 billion-euro ($7.7 billion) initiative to find jobs for young people. That sum is less than 0.01 percent of the 27-nation EU’s GDP.

The commission argued that the extra deficit-reduction time is justified because the economy has tailed off, and said that it granted the concession only to countries that are making economy-boosting reforms to their health care or pension systems or labor markets.

France, for example, was told to fix its pension system by raising the retirement age, reinstating reforms that President Francois Hollande has partly reversed. Rehn spoke of “a sense of urgency to tackle the erosion of competitiveness in the French economy.”

Labor Market

Spain, already granted a one-year deficit-cut extension last year and the recipient of an aid package for its banks, must trim health-care costs and pursue “active” labor market policies, the commission said. It issued no new guidelines for the four countries -- Greece, Ireland, Portugal and Cyprus -- drawing on aid for the public sector.

Deficits have been less of a concern for investors since last year’s European Central Bank pledge of potentially unlimited intervention in bond markets defused the risk of a euro breakup. The market now charges France 52 basis points more than Germany to borrow for 10 years, compared to 190 basis points in November 2011.

“A key concern is that softening the fiscal rules may impact the credibility of the euro zone’s fiscal framework,” Nick Kounis, head of macro research at ABN Amro in Amsterdam, said in a note yesterday. “Short-term growth-enhancing policies are welcome, but the credibility of the fiscal framework needs to remain in place.”

To contact the reporter on this story: James G. Neuger in Brussels at jneuger@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net

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