Sparse Lending Threatens Europe's Recovery

Europe will enjoy a gradual – though unspectacular – economic recovery over the next two years, according to a new set of highly anticipated economic forecasts published by the European Commission on Tuesday (3 November).

But well over a year since EU citizens first awoke to newspapers containing the words "credit crunch," ongoing problems in the bloc's credit market continue to maintain a drag on the region's economy.

"The banking sector is still fragile and credit is stagnating. This is the bad news," said the EU's economy commissioner Joaquin Almunia, while presenting the 200-page forecast report to journalists in Brussels.

"Regarding the situation of the financial markets, the credit flows are close to zero or in some cases even in negative territory," he added.

Two factors appear to be causing the poor flows. On the demand side, a weakened real economy has reduced the need for companies to seek extra financing. Banks may also be hoarding the public funds they have received, reluctant to lend to companies or households.

But supply side problems also exist, said Mr Almunia, pointing to the continued failure of some financial institutions to access funding on international markets due to weak balance sheets frequently contaminated by toxic assets.

However Daniel Gros, director of the Brussels-based Centre for European Policy Studies, puts the emphasis firmly on the former of these two points, and downplayed the existence of a Europe-wide credit crunch.

"The problem is one of insufficient demand," he told EUobserver. "It's not so much consumer demand, which could be stronger, but investment demand and exports."

Gradual recovery

According to the forecasts, the EU's economy is set to exit the recession in the second half of 2009, although the bloc is headed for a contraction of four percent of GDP for the year as a whole. Poland is the only member state expected to see positive growth this year.

The turnaround is thanks largely to government and central bank stimulus, as well as the rebounding global economy, seen especially in Asia. But following the current growth spurt, the union's economy is then predicted to expand by only a moderate 0.75 percent in 2010, as temporary stimulus spending comes to an end.

The effect of the crisis and timing of recovery is also set to vary considerably from country to country.

"Among the larger member states, the contraction in 2009 is bigger in Italy, Germany and the UK, and smaller in France," said Mr Almunia.

But a trend towards real economic recovery excluding stimulus effects is visible, insists the Spanish commissioner who is hoping for a second term, highlighted by the rising business confidence shown in economic sentiment indicators.

EU finance ministers recently made a 2011 start date for stimulus exit strategies dependent on signs of real economic improvement in the commission report.

"With this forecast I will recommend to the finance ministers to confirm that 2011 is the year when the EU should start exit strategies," said Mr Almunia, stressing that some member states will have to start their budget consolidation earlier.

EU growth in 2011 is forecast to be around 1.5 percent.

Deficits and unemployment

Along with the problems of credit flow, member state budget deficits and unemployment levels are further black points that stand out in the report.

Already the vast majority of EU member states are on course to break the EU's stability and growth pact this year, with only Bulgaria likely to keep its budget deficit below the three percent of GDP threshold.

The cost of social security payments, stimulus measures and falling tax returns means the blocks average deficit looks set to rise from 6.9 percent of GDP in 2009, to around 7.5 percent in 2010, before then gradually falling back in 2011.

"The combination of sustained large deficits, lower potential growth and unfavourable demographic trends is a source of major concern regarding the long-term sustainability of public finances," said Mr Almunia.

Compounding the problem, the time delay between economic recovery and job creation means unemployment is set to rise throughout 2010, with a flattening off of job losses not expected until 2011.

Next year will see EU unemployment levels rise from the current nine percent figure to above 10 percent.

"Overall the situation has improved...but we are living in a very uncertain environment," said Mr Almunia.

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