Recovery due to start before the end of year - Solbes

The European Commission predicted this week that, after a poor performance in 2002 and disappointing growth during the first half of 2003, Europe's economic recovery is just around the corner.

The Commission and the European Central Bank (ECB) have been spotting this glimmer of hope for almost two years but, until now, something unexpected has always come along to thwart the turnaround.

During 2002, uncertainty surrounding the international political situation was cited as the biggest factor deterring investors and dampening growth. The recovery was due to begin towards the end of 2002 but war in Iraq and falling stock markets put paid to such hopes.

The Economic and Monetary Affairs Commissioner, Mr Pedro Solbes, believes, however, that the upturn is now imminent.

"The prolonged slowdown, the ongoing balance sheet adjustments and the fall in stock markets have led to the postponement of investment plans. However, there are encouraging signs that the worst is behind us. An upturn in business confidence is apparent, while consumer confidence is also showing slow but steady signs of improvement," he said.

Mr Solbes expects the recovery to start before the end of this year - any moment now, in fact.

It will not be enough, however, to lift economic growth in the euro zone above a meagre 0.4 per cent in 2003. Next year, growth is expected to rise to 1.8 per cent, with the euro-zone economy growing by 2.3 per cent in 2005.

Although these figures represent an improvement on the stagnation experienced in the European economy earlier this year, they fall far short of the expectations raised in Lisbon in 1999, when EU leaders vowed to make Europe the most competitive, dynamic, knowledge-based economy in the world by 2010.

"These forecasts indicate clearly that, despite substantial efforts in the framework of our Lisbon strategy, Europe's growth potential remains low and that more structural reforms will be needed," Mr Solbes said.

"Our major challenge during the upturn will be to raise our growth potential. We should not miss this chance this time as we did in the last upturn in 1999-2000," he added.

Unfortunately, some of the EU's core economic policies appear to have become an obstacle in the way of Mr Solbes' hopes of increasing growth potential.

In the Republic, for example, investment in better infrastructure is universally identified as a prerequisite for improving competitiveness. Under the EU's accounting system, however, the Government cannot finance an adequate level of infrastructure development, even in public-private partnerships, without breaching the rules of the Stability and Growth Pact.

Germany and France, Europe's two biggest economies, are already in breach of the pact's 3 per cent limit on budget deficits and the Commission warned this week that both countries will continue to violate the rules in 2004 and 2005 unless they change their economic policies.

The outgoing president of the ECB, Mr Wim Duisenberg, yesterday gave EU finance ministers a stern, parting lecture on fiscal rectitude. He told them that the Stability and Growth Pact was a contract with Europe's citizens and that breaching it risked a loss of confidence in the euro.

"I acknowledge that these are not easy times, that conditions are adverse. But the difficulties that some of you now face were not entirely unforeseen - not unforeseen when the pact was signed, not unforeseen when the conditions were more favourable. You were warned," Mr Duisenberg said.

"The rules were not designed just for the good times, but also for the bad. The difficulties that some of you now face do not provide grounds for tinkering with the rules. They call for their implementation. The rules are there to help, not to hinder efforts to put the house in order. They should be allowed to do what they were designed for. Otherwise I fear the pact will unravel, the contract with the people will be broken. Without the right foundations, you cannot build a stable house," he said.

The Commission hopes that improved economic growth will help euro-zone governments to keep within the pact's rules. But this week's report acknowledged that there was no certainty that the euro-zone economy will grow even by the modest measure predicted.

The US and Asian economies are showing signs of improvement and a simultaneous acceleration of growth would reinforce the European recovery.

"However, long-standing macroeconomic imbalances may hold back a sustained expansion of the US economy. The Japanese economy is still in the early stages of recovery from its protracted recession. Therefore, the international environment might turn out to be less benign than assumed," the report said.

A sharp rise in the euro's value against other currencies could make life difficult for manufacturers by making exports less competitive on the world market. The Commission is confident, however, that the reduction in international tension following the end of the military campaign in Iraq has opened the way to renewed confidence and better growth prospects.

"The protracted nature of the downturn, the uncertainties related to the Iraq war and the balance sheet adjustment in the corporate sector have sapped confidence, leading to the postponement of consumption and investment plans. With the resumption of confidence, the release of such pent-up demand would accelerate the return to potential growth," it said.