Strengthening the Recovery for Europe

Growth projections for Europe revised up to 2½ percent for this year and next

Important challenges remain to overcome sovereign debt problems in the euro area

Solid recovery under way in emerging Europe but risks should be addressed

Growth is set to be stronger in Europe’s emerging market economies than in its advanced economies. For both parts of the continent, downside risks to the outlook dominate, with the sovereign debt trouble in the euro area being the most pressing challenge facing policymakers.

Substantial measures have already been put in place in the euro area to overcome the crisis. At the national level, strong adjustment policies are being implemented to rebuild and bolster confidence. At the regional level, the crisis management capacity of the European Union (EU) is being strengthened, and the governance framework revamped. Important actions are still required to deal decisively with weak banks across Europe’s advanced economies, and to follow through with implementing the EU-wide reforms that have been agreed in principle.

The risks to the outlook in Europe’s emerging economies will also diminish as financial tensions in the euro area are addressed. Nonetheless, the deep recession of 2009 has left fiscal and financial buffers depleted that now need rebuilding. This is particularly true for public finances, but it also applies to the financial sector, where many banks still have not recovered sufficient ability to lend.

Risks remain to euro area outlook

Growth in the euro area picked up to 1.7 percent in 2010 and is projected to be 1.6 and 1.8 percent in 2011 and 2012. Countries that had steered clear of large current account deficits, excessive debt, and real estate bubbles in the pre-crisis years have managed to rebound quickly from the global crisis thanks to their highly competitive economies. Germany and Sweden in particular have enjoyed buoyant growth.

But countries that built up excessive debt and leverage before the crisis in 2008 are now going through a difficult period of adjustment. Greece, Ireland, and Portugal all had to fall back on financial support from the EU and the IMF. Their near-term growth prospects are clouded, but the support packages now in place include a number of measures designed to cushion the adjustment and restore growth over time.

With the sovereign debt problems contained to just a few, relatively small economies that have limited importance as export markets for the rest of...