The outgoing 2009 proved a very tough year for the European Union (EU). The worst financial turmoil in decades has plunged the combined economy of the 27-nation bloc to its bottom.

While a precarious rebound is underway, the next year would be a crucial test for the EU to manage all risks and sustain the economic recovery WORST RECESSION ON RECORD The financial turmoil, which originated in the United States last September and soon spread to Europe, dragged the EU economy into the deepest, longest and broadest-based recession in the history of the 27-nation bloc.

It was estimated by the European Commission that the EU economy is set to shrink 4 percent this year, the biggest fall in output since the Second World War, and the cumulative output loss of 5 percent since the recession started in the second quarter of 2008, or some four times as much as the average loss in the previous three recessions.

Fortunately, confidence indicators and hard data since the summer have increasingly showed signs of improvement in the economic situation.

After negative growth in four consecutive quarters, the EU economy expanded by 0.4 percent quarter on quarter, marking the end of what has been known as the “Great Recession.” But the outlook remains uncertain as the better-than-expected rebound was underpinned by the massive support provided by governments and central banks worldwide. As such support depends on the ability of the banking sector to increase the present levels of lending to the economy, it would eventually scale back. The commission forecast in November that the EU economy would grow by 0.7 percent in 2010 and 1.6 percent in 2011, much lower than the around three-percent growth in the past years.

THREE MAJOR RISKS AHEAD As its economic recovery is gathering momentum, the EU is faced with three major risks, namely a still fragile financial system, swelling government deficits and rising unemployment.

Despite billions of euros the EU governments spent on financial bailouts, European financial markets remained under stress. The global markets shivered at the news that Dubai World was delaying debt service, only to reveal how fragile and nervous they are.

Another risk is the EU’s soaring public finance deficit pushed up by financial bailouts and economic stimulus. The overall government deficit in the EU is expected to reach 7.5 per cent of gross domestic product (GDP) by 2010, far beyond the 3-per cent ceiling set by the EU’s stability and growth pact.

The seriousness of ballooning deficits was highlighted by the recent downgrading of the credit worthiness of Greece by the international rating agency Fitch, which led to concern of the deteriorating economy.

Similarly, public debt, bearing the brunt of the crisis, is expected to reach 79.3 percent of GDP by 2010 in the EU.

Swelling government deficits and debt are threatening economic stability and long-term sustainability.

Meanwhile, the continued, albeit more moderate, increase in unemployment is a source of concern both socially and economically.

The recession has caused deterioration in the labor market. In October, unemployment rate in the EU rose to 9.3 percent. It was set to increase further, reaching 10.3 percent in 2011.

Rising unemployment would dampen consumption, a key engine of economic growth.

NEXT YEAR CRUCIAL The forthcoming 2010 will be a challenging and decisive year for the EU economy to sustain the emerging recovery amid a host of risks.

Looking back on 2009, solid groundwork has been put in place to go ahead. Recognizing that the economy cannot rely on government support forever, EU finance ministers decided in October to start fiscal consolidation in 2011 at the latest. Furthermore, countries deep in debt should begin to consolidate its deficit earlier than 2011, according to a EU document.

This means some EU member states have to consider phasing out their economic stimulus as early as next year.

But the timing of the exit strategy is crucial since an early end to fiscal stimulus would hurt recovery, while a late withdrawal would increase the risk of inflation and threaten long-term stability.

Meanwhile, the year 2010 will be crucial for making progress in financial sector repair as the banking sector continues to be under stress.

The EU is reworking its financial market supervisory architecture. To better bolster the stability of European financial markets in future, a new European Systemic Risk Board would monitor macro-prudential risks and issue warnings and recommendations for policy action if risks are judged significant.

In addition, three European supervisory authorities for banks, insurance and securities markets would be created with a view to unifying supervisory practices among member states and to ensuring efficient handling of a financial emergency.

The new system was expected to take place in the course of 2010 to help maintain the EU’s financial and economic stability.

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