Budget cuts must go on, EU’s Rehn says

Europe will need more spending cuts to emerge from its debt crisis despite an admission by the International Monetary Fund that cost cutting can choke economies, the EU’s top economic official said on Friday.

The damage from aggressive austerity may be up to three times more than previously thought, the Washington-based lender said late last year, after earlier prescribing sharp deficit cuts to the eurozone. It has since shifted its advice, now arguing against forcing heavily indebted countries such as Greece to reduce their deficits too quickly.

The EU Economic and Monetary Affairs Commissioner Olli Rehn said the IMF’s October study, which was updated this month, was not applicable to everyone and did not take into account that investors expect governments to act to control their debt.

“You have to take into account the confidence effect,» Rehn told diplomats and executives during a speech in Brussels, adding that the impact of austerity differed across countries depending on whether they still had access to markets.

The difference in opinion appears to mark a split within the «troika» of international lenders – the Commission, the IMF and the European Central Bank – over how to deal with fragile European economies trying to pull out of recession in 2013.

Against a backdrop of record unemployment, many economists believe spending cuts in almost all euro zone countries drove the bloc into its second recession since 2009 last year.

But ECB chief Mario Draghi rejected any idea of easing up on efforts to reduce sovereign debt.

“So much progress accompanied by so big sacrifices have already taken place that to revert to a situation that has been found to be untenable would not be right,» he told the ECB’s monthly news conference on Thursday.

Rehn said that government spending cuts had now made budgets and public debt loads more sustainable but that more had to be done because debt burdens were still high.

“What would have happened if Italy would have loosened its fiscal policy in November 2011?» Rehn asked.

“The reason why the bond yields of Italy started to rocket north was precisely because Italy did not respect its commitments,» Rehn said, recalling the political instability and surge in borrowing costs that forced Silvio Berlusconi, the then prime minister, from office.

Huge budget deficits have been at the heart of the eurozone’s problems following a decade of credit-fueled growth and ensuing bank rescues by governments when property bubbles burst.

Greece’s budget deficit reached 15.6 percent in 2009 after the outgoing government revealed it had hidden its borrowings, setting off a crisis that spread to the rest of the eurozone.

“Let’s face it, Italy has a public debt of over 120 percent,» Rehn said. He also singled out France and Spain as countries that need to meet EU-mandated fiscal targets this year, declining to say whether they would be given more time.