BRUSSELS The European Commission warned of deepening economic problems in France, Italy and Spain on Wednesday, and said Slovenia must take urgent steps to offset the risk of a wider destabilization across the euro zone.
Unveiling its second review of economic imbalances in 13 European Union countries, the Commission flagged concerns about France and Italy, while including Spain and Slovenia among countries that could face fines if they do not correct course.
The early warning system was set up after problems in Greece, Ireland and Portugal triggered the euro zone sovereign debt crisis and forced the bailing out of four member states.
"(In) Spain and Slovenia, imbalances can be considered excessive," said the Commission, mentioning problems with high deficits and public debt levels, imbalances in the banking system and in labor market structure and costs.
In Spain, which had to borrow 40 billion euros from the euro zone last year to recapitalize its shattered banks, it said very high domestic and external debt levels posed serious risks for growth and financial stability.
"Although adjustment is taking place, the magnitude of the necessary correction requires continuous strong policy action," the Commission said. Under the macroeconomic imbalances procedure, a country that does not take steps to remedy excessive imbalances can be fined 0.1 percent of GDP by the EU.
Perhaps more concerning are growing signs of imbalance in France and Italy, the euro zone's second and third largest economies, even if they are not yet deemed "excessive".
If those problems were to worsen, it would signify that almost no EU economy, save perhaps Germany, is immune from the impact of the debt crisis, and borrowing costs across the region would be likely to rise in reflection of that risk.
The Commission described France's resilience to external shocks as "diminishing" and its medium-term growth prospects as "increasingly hampered by long-standing imbalances".
France's share of the EU's export market declined by 11.2 percent between 2006 and 2011, the report said, while rising unit labor costs have eaten away at Its competitiveness.
"It is necessary for us to reduce risk adverse effects on the functioning of the French economy and the whole euro zone," economic affairs commissioner Olli Rehn told reporters, citing France's deteriorating export performance and high public debt.
"Why so? Because France is a core country, France is, in terms of its size and economic position, a very significant member of the euro zone."
French President Francois Hollande promised on Wednesday to stick with deficit-cutting plans despite a growing revolt within his government over reductions that critics say bow too much to German demands for austerity.
The EU had similar words of warning for Italy, where public debt is forecast to rise to 130 percent of GDP, far above the level considered sustainable, although the Commission also said its budget deficit was largely in check.
SPAIN AND SLOVENIA
Spain and Slovenia, seen at risk of being the fifth euro zone country to need a full sovereign bailout, could face fines if they are unable to correct imbalances in their economies.
"Developments over the last year, including further contraction in economic activity, rising unemployment, and the need for public support for the recapitalization of a number of banks, have exposed the vulnerabilities represented by those imbalances for growth, employment, public finances and financial stability," the Commission said of Spain.
Unemployment in Spain is likely to reach 27 percent this year as a second full year of recession bites. The economic contraction could extend into 2014, the Commission said.
Reforms aimed to improve public finances, create jobs and increase competitiveness are underway, but are not yet complete or have not yet started to bear fruit, the Commission said.
Slovenia also faces substantial risks to the stability of its financial sector because of corporate indebtedness and deleveraging and the sector's links with public finances.
A relatively large bad loan portfolio is threatening the stability of Slovenia's banks and has raised investor concerns that it may be the next candidate for emergency euro zone loans.
"Urgent policy action is needed to halt the rapid build-up of these imbalances and to manage their unwinding," the Commission said.
It suggested Slovenia should recapitalize and privatize banks and sell-off state-owned firms to draw in foreign investment and restrain wages to make exports more attractive.
Both countries must tell the Commission before the end of April how they want to address the problems and the EU executive will issue recommendations for them at the end of May.
(Reporting By Jan Strupczewski; Editing by Luke Baker and Catherine Evans)