EU Countries Face Large Budget Deficits

European capitals are likely to continue running high deficits in 2010, but the following year should see a "very substantial" reduction in countries' debt burden, the European Commission has suggested in a strategy document for EU finance ministers.

"Considering the fragility of the recovery, no consolidation is advocated on aggregate in 2010, as the planned stimulus measures should still be implemented and government revenues remain subdued," reads the paper prepared for a ministerial meeting later this week (1-2 October).

The informal meeting in the Swedish city of Gothenburg will centre on how to exit from unprecedented rescue measures for ailing economies as well as how to tackle growing debts.

The 27-nation EU believes that its economy—although no longer in free fall—cannot survive on its own and an abrupt withdrawal of stimuli would choke any recovery.

According to the commission paper, budgetary support should be reduced from 1.1 percent of GDP this year to 0.7 percent next year and should be largely withdrawn from 2011. European banks should continue having access to schemes such as guarantees on debt issuance or relief on impaired assets until end of June 2010.

UK Prime Minister Gordon Brown, for his part, confirmed on Sunday (27 September) that his government would maintain public investment "as long as we are in recession and as long as there is the need to ensure the economy is strong."

Save and reformHowever, doing nothing or acting too late could also backfire, warn critics of the steady-as-she-goes approach, who argue that this could drive up inflation and borrowing costs, with households and firms saving rather than spending.

"The absence of a roadmap for the future course of policies can make the crisis more persistent," Brussels says. The commission expects member states to start major budget deficits cuts no later than in 2011.

"From 2011, when the economic recovery is assumed to be on a firm footing, a generalised and very substantial fiscal consolidation will be required to reverse the worrying debt trends," the paper says.

In practice, most governments should slash deficits by more than 0.5 percent of GDP—and in many cases by over one percent—for several years, although it is "virtually impossible" to achieve it by spending cuts alone.

Tax rises—most recently announced by Spain—are likely to be seen in various EU states. The Spanish government, for its part, is set to raise an extra €11bn a year with austerity measures that include higher income and value-added taxes.

Brussels predicts that without a return to tighter public finances, the EU's debt is set to reach 120 percent in 2020—twice the maximum allowed under current rules. Ireland alone would have debt of 200 percent of GDP by the end of the next decade.

But the fact that the EU is unlikely to return to previous economic growth rates—as a result of the crisis and the ageing of population—could diminish governments' appetite for fiscal discipline, something Brussels warns against.

"Lacklustre growth rates should not be considered as a reason for delaying the exit strategy."

Tax and benefit-system reforms together with pension-scheme reforms and greater emphasis on education, innovation or green technologies, are also among the key tasks for governments.

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