Last updated: May 3, 2013 7:23 pm

Brussels relaxes austerity across the eurozone

Flags of the EU member states fly in front of the European Parliament in Brussels©AFP

Brussels has for the first time signalled its willingness to relax austerity across the eurozone as EU forecasts showed the currency bloc’s recession was becoming longer and deeper than anticipated just three months ago.

Olli Rehn, the EU economic affairs commissioner, said he was willing to give France – whose economy is flatlining rather than contracting sharply – as well as Spain two more years to hit tough Brussels-mandated deficit targets. With the Netherlands also given an extra year, three of the eurozone’s five largest economies will be allowed to slow the pace of belt-tightening.

Under new rules adopted in the wake of the eurozone crisis, all three were supposed to get annual budget deficits under 3 per cent of economic output this year or face fines. But new data released by Mr Rehn showed them widely missing the mark, and Italy, the single currency’s third largest economy, only narrowly avoiding a breach with a deficit of 2.9 per cent.

The two years’ grace period for France was particularly unexpected, since Paris had only requested a single extra year and some in Germany – particularly senior Bundesbank officials – have publicly objected to any loosening of the just-adopted fiscal rules.

But Mr Rehn said the deepening recession made it unwise to force Paris into the kind of swingeing cuts required to get its 2014 deficit, now projected at 4.2 per cent, below the EU’s 3 per cent limit. Mr Rehn downgraded forecasts across the eurozone, with the bloc now projected to contract 0.4 per cent this year.

“In order to bring the deficit below 3 per cent next year, as envisaged by the French authorities, a significantly larger and front-loaded effort of fiscal consolidation would be required compared to what is currently planned,” Mr Rehn said.

Despite Mr Rehn’s warning, the French finance ministry said it would stick to its revised plan to get under 3 per cent next year, arguing the Brussels forecasts did not include savings they are planning for next year’s budget.

Still, French officials cautioned hitting the new 2.9 per cent target in 2014 would depend on growth. Pierre Moscovici, the French finance minister, said he believed growth would be “a little higher” than Mr Rehn’s new forecast of a 0.1 contraction next year.

Even as he offered leniency on budget targets, Mr Rehn warned that growth forecasts by President François Hollande’s government remained “overly optimistic” because of persistent unemployment and said Mr Hollande must do more to reform the French economy or face continued deterioration.

“I dare say, even more important for France – and as France is a core country for the eurozone, for the eurozone in its entirety – is that France put a renewed and strong emphasis on structural reforms in the labour market,” Mr Rehn said. “France badly needs to unblock its growth potential and create jobs.”

Mr Moscovici welcomed the additional time, saying he was happy Mr Rehn had focused on economic reforms rather than headline deficit figures.

“The government reaffirms that the deficit reduction effort must not penalise growth,” Mr Moscovici said in a statement, adding that the dire economic forecasts showed “the importance of a strategy and measures in favour of growth in Europe, as France has demanded for a year”.

But the French finance ministry sought to play down any divergence between Brussels and Paris on the pace of France’s economic reforms. “I think we agree,” said one official. “We have accomplished a lot already. We agree that more needs to be done and it will be done.”

Despite three years of austerity-driven crisis response, Friday’s forecasts showed eurozone sovereign debt continuing to skyrocket, projected to rise to a euro-era record of 96 per cent of gross domestic product next year. Greece continued to lead the pack at 175 per cent, but four other countries are expected to hit the symbolically important 120 per cent level next year: Italy at 132 per cent; Portugal, 124 per cent; Cyprus 124 per cent; and Ireland, 120 per cent.

The Cyprus projections are the first public forecasts since last month’s botched €10bn bailout and showed its economy shrinking by 8.7 per cent this year and another 3.9 per cent next year.

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