EU must slash deficits from 2011 - Commission

By Jan Strupczewski

BRUSSELS, Sept 18 (Reuters) - The European Union must start major budget deficit cuts in 2011 to prevent debt spiralling out of control after governments spent hundreds of billions of euros to help the economy, a European Commission document said.

The document is for a meeting of EU finance ministers on Oct. 1-2 at which they will discuss how to withdraw those public funds.

"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," said the document, obtained by Reuters.

EU leaders agreed on Thursday that fiscal stimulus, seen at around 5 percent of the 27-country bloc's gross domestic product this year and next, must continue in 2010 until recovery is assured.

"From 2011 generalised, very substantial -- but differentiated across countries -- fiscal consolidation is required to reverse the worrying trends in the debt-to-GDP ratio," the Commission document said.

Countries with high debt and large external imbalances or competitiveness problems should start consolidating early even if their recovery would be perceived as weak and delayed.

Those with more fiscal room to manoeuvre could phase out the stimulus gradually, the Commission said.

The Commission said most countries would need to cut their budget deficits by much more than 0.5 percent of GDP a year and some by more than 1 percent -- for several years -- to break the trend of fast-rising debt.

If growth next year is stronger than expected, any windfall revenues should be fully used to reduce borrowing, it said.

Consolidation will be made harder because the crisis will have reduced potential EU growth even below the 1 percent a year that is expected as societal ageing takes its toll.

"Therefore, lacklustre growth rates should not be considered as a reason for delaying the exit strategy," the document said.

If economic recovery gathers pace in 2010 and there is no additional stimulus, EU government debt levels would hit 100 percent of GDP in 2016, and rise to 120 percent in 2020 unless policies change. EU debt was 61.5 percent of GDP in 2008.

Britain, Ireland and Latvia would have debt between 175 and 200 percent of GDP in 2020 if they failed to make further efforts to consolidate public finances beyond withdrawing fiscal stimulus, a graph in the document showed.

The necessary deficit reductions are so big that it will not be possible to achieve them by only cutting expenses -- taxes will have to rise, the Commission said.

REFORM AND COORDINATE

Exit strategies must also include structural reforms that would boost potential growth, especially by cutting the cost of pensions, raising the retirement age and stemming cost increases in the health sector.

The exit strategies, however, should be globally coordinated to prevent negative spillover across borders and sectors.

Major central banks around the world should coordinate the withdrawal of monetary stimulus to avoid exchange rate swings.

Government support for the financial sector would need to remain a while longer, especially guarantees on debt issuance and recapitalisation schemes, the Commission said.

"The fragility of the recovery suggests the need to prolong the possibility for banks to have access to these schemes until the end of June 2010," the document said.

But it said the price of government support, now below market, should gradually rise to market levels or even above to push banks back to private markets for capital.

It said asset writedowns in the banking sector should be accelerated so that credit channels would work properly when the time came to withdraw fiscal stimulus.

A stronger emphasis should be put on bank restructuring, it added. (Editing by Dale Hudson)