EU sees deflation risk if no reforms

[April 20, 2010]  BRUSSELS (AP) -- The European Union's economy commissioner warned that Europe's debt crisis could trigger deflation across the 16 nations that use the euro if Greece and others don't make tough reforms.

He said it wasn't enough for Greece and other "deficit countries" to reduce their budget gaps in coming years and not make reforms to the wider economy -- such as opening up the labor market, allowing more competition between companies and training workers for skilled jobs.

Ultimately, a failure to reform these economies could trigger deflation -- or a fall in real prices -- across the entire 16-nation euro area, he warned.

"We may face a situation where we have deflationary developments in the whole euro area," he said.

Greece is under pressure to make its economy more competitive in the long-term. Countries often do that by devaluing their currency, a choice Greece does not have because it is part of Europe's currency union.

This means it must make other efforts, such as curbing wage levels -- or risk its problems affecting other euro nations. Rehn praised Greek moves to slice 10 percent of the public sector wage bill as "an important signal which should be followed in the private sector."

He also said Greece, which now has access to a last-ditch financial backstop from other eurozone governments, would not default on its debts. "Default is not an issue. There will be no default," Olli Rehn told a conference organized by the European Policy Centre think-tank.

He also said he had "no reason to doubt" that Germany would join a bailout for Greece even though the German parliament will likely debate and vote on whether to grant a loan. Germany's share, at euro8.4 billion, is the largest part of a euro30 billion eurozone financial backstop.

"Germany is committed like the other 15 euro area member states to participate ... if requested and if needed," he said.

Financial markets are charging higher interest rates for Greek bonds because they believe the country may be unable to repay growing debt while its economy grows slowly.

Greece says it can't afford to keep borrowing at such high rates and has secured a loan package from other eurozone nations and the International Monetary Fund to be used as a last resort if it can't borrow from markets for the euro54 billion it needs this year.

As part of tighter oversight over eurozone economies, Rehn also suggested that eurozone governments should submit their draft budgets and overall spending targets to the European Commission for it to analyze -- before they have sent them to national parliaments.

He said he backed some eurozone bailout fund to lend to member countries in trouble. EU President Herman Van Rompuy will set out options by year-end for EU governments to decide on.

[Associated Press; By AOIFE WHITE]

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