Slovenia and Spain must take ‘urgent action’ to stop spread of euro crisis

The European Commission warned of "excessive" risks to the economic health of Slovenia and Spain, calling on both governments to take urgent action to stem the spread of the euro crisis.

Slovenian banks are likely to need fresh capital injections as over-indebted corporate borrowers struggle to pay back loans amid a double-dip recession, the Brussels-based commission said.

It said Spain is encumbered by public and private debt. Slovenia's ailing banks have made it a target for financial markets, with shrinking demand in a debt auction yesterday signaling investor expectations that it will be forced to seek a bailout.

Spain is already tapping aid for its banking system. Political gridlock and legal snags "have prevented Slovenia from addressing its imbalances adequately and enhancing its adjustment capacity, thus increasing its vulnerability at a time of heightened sovereign funding stress in Europe, " the commission, which enforces European Union regulations, said in a report today.

Both countries were given a May 29th deadline to make reforms or risk becoming the first to be punished under a year-old "macroeconomic imbalances procedure" designed to deal with the lagging competitiveness and overstretched banking systems that fueled the debt crisis.

Economic Policy

The commission detected less severe imbalances in 11 other countries: euro members Belgium, Finland, France, Italy, Malta and the Netherlands, as well as euro outsiders Bulgaria, Denmark, Hungary, Sweden and Britain.

While all were urged to adjust economic policy, none were threatened with the disciplinary procedure that could lead to fines.

The assessment is a "wake-up call for several member states to take decisive action for restoring competitiveness," European Union Economic and Monetary Affairs Commissioner Olli Rehn told reporters.

Today's recommendations will test whether European authorities have gotten ahead of the curve in dealing with the more than three-year economic and fiscal crisis or remain a step behind in anticipating the next country to face the bond market's wrath.

'Further Recapitalizations'

Slovenia, with a €35 billion-euro economy that makes it the fourth smallest in the 17-nation euro zone, lurched into the crossfire after European creditors and the International Monetary Fund forced losses on bank depositors in last month's aid package for Cyprus.

While Slovenia is less reliant on banking than the Cypriot economy, it faces a credit contraction that leaves the state as the main source of capital and "further recapitalizations are likely to be needed," the commission said.

On her first trip to Brussels yesterday, newly elected Slovenian prime minister Alenka Bratusek said the government is determined to avoid falling back on financial aid, echoing pledges once made by leaders in Greece, Ireland, Portugal, Spain and Cyprus.

The commission's recommendations for Spain focused on the "negative feedback loops" of recession, unemployment heading toward 27 per cent, and rising household and government debt.

Spain needs more deregulation in the transport and energy industries, more wage flexibility, better access to financing for small and midsized companies and a "structural" long-term solution for the social security system, the commission said.

' Additional Reforms'

"Despite significant progress last year, there are still excessive macroeconomic imbalances," Mr Rehn said.

While the commission flagged risks in Finland and the Netherlands, two countries that have conserved AAA credit ratings throughout the crisis, it didn't take on Germany, which has faced criticism elsewhere for running sizable external surpluses.

In contrast, France and Italy, the second- and third- largest euro economies, were cited for declines in competitiveness, further evidence of how the crisis has turned Germany into Europe's undisputed powerhouse.

Mr Rehn defended the decision to spare Germany, saying that its current-account surplus with the rest of the euro area has declined since 2007. Still, he urged Germany to spur consumer demand by deregulating service industries, getting more women into the workforce and allowing wages to rise in line with productivity.