European debt crisis remains biggest threat to world economy – UN report

The European debt crisis is currently the biggest threat to the world economy, according to a United Nations report released today, which warns that the austerity measures followed by countries in the region will plunge them further into recession, and calls for a shift in fiscal policies to stimulate growth.

“An escalation of the crisis could result in severe turmoil in financial markets and a sharp rise in global risk aversion, leading to a further weakening of global growth,” states the UN World Economic Situation and Prospects (WESP) 2012 mid-year update.

Produced by the UN Department of Social and Economic Affairs (UN DESA), the UN Conference on Trade and Development (UNCTAD) and the five United Nations regional commissions, the report flags that most developed countries are still trying to recover from the 2008-2009 global financial crisis, and notes fiscal austerity measures aimed at ameliorating the debt situation are backfiring.

“The severe fiscal austerity programmes implemented in many European countries, combined with mildly contractionary policies in others, such as Germany and France, carry the risk of creating a vicious downward spiral with enormous economic and social costs,” it notes.

The report stresses that it is essential to change the course in fiscal policy and shift the focus from short-term consolidation to medium- to long-term fiscal sustainability. It also emphasizes that fiscal policies should be internationally coordinated and should support direct job creation and green growth.

High unemployment, deleveraging by banks, firms and households, and bank exposure to sovereign debts are also contributing factors to the economic downturn, the report says, noting that European countries in particular are struggling to overcome these weaknesses.

The update warns that the situation in Italy and Spain currently poses the biggest danger for the euro area as the size of their debts would likely challenge the region’s rescue funds.

“The main fear is that Spain will slide deeper into recession, driving up its borrowing costs, leading to increased market turmoil and eventually requiring a bailout,” the report states. “This would leave insufficient funds available for Italy and renew speculation on a break-up of the euro area, further unsettling financial markets and triggering a downturn in global economic activity.”

In addition to a shift in fiscal policies, WESP recommends that monetary policies be better coordinated internationally, and calls for an acceleration of reforms in the financial sector.

WESP projects that world gross product will grow by 2.5 per cent this year and 3.1 per cent in 2013, following growth of 2.7 per cent last year – slightly lower than the forecasts it presented in January.