IMF sees tepid recovery in Europe

NEW YORK (CNNMoney.com) -- The European economy is expected to grow at a slow pace next year as the region continues to struggle with huge public deficits and the lingering effects of the financial crisis.

In its latest economic outlook for Europe, the International Monetary Fund said Wednesday that activity across the region will expand at an annual rate of 2.3% this year, before easing to 2.2% in 2011.

The European economy, which includes the 27 members of the European Union and 16 other non-member nations, shrank 4.6% in 2009.

"What's encouraging is that the recovery in Europe is continuing," said Ajai Chopra, Acting Director of the IMF's European Department, in an online interview. "And this is happening despite the problems in the sovereign debt markets."

However, economic activity in Europe will be weak by historical standards, he added, warning that risks to the forecast are mainly to the downside.

"The fact that we have the same growth forecast for both years itself suggests that there's not a lot of momentum behind this recovery," Chopra said.

The sluggish recovery in Europe is being driven by improvements in the global economy, which is helping export-driven economies such as Germany, the IMF said.

Overall economic activity among so-called advanced European nations is expected to grow by 1.7% in 2010 and 1.6% in 2011, according to the report.

By contrast, the IMF expects emerging economies in Europe to have growth of 3.9% in 2010 and 3.8% in 2011. This group is made up of mostly Eastern European nations that were hit hard during the recession, but have since rebounded sharply.

The IMF said the fallout from the 2008 financial crisis continues to take a toll on large European economies. But the dim outlook also reflects "well-known structural rigidities in the labor, product and services markets," the report said.

In France, for example, labor and student unions have staged large-scale protests this week against a proposed increase in the retirement age that have disrupted travel and commerce across the country.

The United Kingdom has also enacted strict austerity measures this year to deal with record deficits. In addition, the debt problems in Greece, Ireland, Italy, Portugal and Spain have become so severe that investors around the world have dubbed the group PIIGS.

"It's clear that the great recession has left deep scars in public finances everywhere," said Chopra. "It is essential for countries to develop plans now and for the next few years to demonstrate that debt is on a firmly downward path and also that fiscal sustainability is assured."

To help prevent a repeat of the recent crisis, the IMF called on European policymakers to strengthen the banking sector as soon as possible.

Chopra said it's critical for policymakers to quickly identify institutions in Europe that pose a threat to the regional financial system and make sure they have sufficient capital. If they don't, he said regulators should restructure or resolve banks that are beyond repair.

The recent stress tests conducted on banks in the European Union were a good first step, but more needs to be done, Chopra added. Governments need to cooperate across borders and enact "enhanced" supervision of Europe's financial system, he said.

"A number of initiatives are already in train. We need to wrap them up, get regulatory clarity, and implement," he said.