OECD sees euro zone growth rebound, peripherals a risk

BRUSSELS (Reuters) - The euro zone economy is slowly recovering thanks to fiscal stimulus and better trade, but weak competitiveness and public finances in peripheral economies pose a risk, the OECD said in a report on Wednesday.

The Organization for Economic Co-operation and Development said the euro zone economy was likely to expand 1.2 percent this year and 1.8 percent in 2011 -- a more optimistic forecast than the European Commission's 0.9 and 1.5 percent respectively.

"A gradual recovery is underway driven by economic policy stimulus, a rebound in world trade and improving financial conditions, although there has recently been significant financial market volatility," the report said.

"Difficulties in restoring competitiveness and sound public finances in some peripheral countries may complicate recovery," the OECD said.

The peripheral countries are Greece, Ireland, Spain and Portugal, all of which had to introduce austerity measures to convince markets that they would be able to repay their debts.

"Deep and sustained fiscal consolidation, coupled with structural reforms, are key to restoring confidence and growth," the OECD said about Greece.

"Success in reining in public expenditures, with reforms in pensions and improvements in public sector efficiency, are crucial to the success of the program," it said.

Greece secured a 110 billion euro ($135 billion) emergency loan package from the euro zone and the International Monetary Fund after markets effectively refused to keep on lending to Athens.

But market concern subsequently turned to Spain and Portugal, which, despite a debt-to-GDP ratio much lower than in Greece, also suffer from slow growth and low competitiveness.

This forced euro zone countries to put together with the IMF a 750 billion euro three-year safety net of loans for any euro area state which could not borrow at sustainable rates on the market.

Economists note, however, that while the possibility of getting emergency loans solves the problem of immediate financing, it does not resolve the underlying problem of bloated public finances, low growth and weak competitiveness.

The OECD said Spain should implement its budget consolidation plans which envisages a reduction of the deficit to 7 percent of GDP in 2011, and embark on a pension reform to put public finances on a sustainable basis.

"A failure to achieve sufficient fiscal consolidation will affect investor confidence," the OECD said of Spain, forecasting its economic growth would still be negative this year at -0.2 percent but inch up 0.9 percent in 2011.

Economic growth in Portugal is likely to remain weak at 1.0 percent this year and 0.8 percent in 2011 as fiscal consolidation cuts government spending and high indebtedness and unemployment reduce household demand.

"Despite a recovery in external demand, poor competitiveness undermines export growth: both the rise in labor costs during the crisis and weak productivity make it unlikely that Portugal will regain market share over the projection period," the OECD said.

Ireland will continue to contract this year with a 0.7 percent drop in GDP but growth is likely to rebound in 2011, the OECD said, forecasting a 3 percent expansion.

The Irish economy will not get any much help from government spending, as Dublin will have to continue slashing its large budget deficit, seen at 11.7 percent of GDP this year and 10.8 percent in 2011. Ireland wants to bring its deficit below 3 percent in 2014.

"The government's medium-term fiscal strategy rests on an optimistic macroeconomic scenario after 2010, which, if it does not materialize, could threaten the pace of fiscal adjustment and consequently weigh on market confidence, posing a risk to the outlook," the OECD said.

The report said that while growth in the 16 countries using the euro was likely to strengthen in the coming quarters, the pace of fiscal consolidation and its dampening effect on demand was a significant downside risk.

It said long-term budget deficit cutting plans of euro zone countries published in February suggested discretionary budgetary tightening in the euro area of more than 1 percent of GDP in 2011 and 2012.

"The fiscal adjustment needs and difficulties in restoring competitiveness in some euro area countries may complicate recovery and monetary policy exit," it said.

(Reporting by Jan Strupczewski, Editing by Ruth Pitchford)