In its country-specific report on Spain, the Commission said the latest banking reform presented this month did not go far enough and needed to be strengthened to include provisioning on mortgages and lending to small businesses.
It also warned that unless policies are changed, Spain's debt will spiral to 100% of GDP by 2020. Madrid had one of the lowest debt ratios in the euro zone before the crisis at about 35 percent of GDP.
Greek contagion – fears for Cyprus
Spain continued to experience a surge in ten-year bond costs yesterday as policymakers mulled how to solve the yawning liquidity gap in the the country’s troubled banking sector.
Cyprus, which some fear may be the next eurozone country to need a bailout because of its exposure to Greece, was warned to introduce extra spending cuts this year to reduce its deficit, increase the state retirement age, and bear down on the public sector pay by reforming allowances.
The report on Italy was less negative in outlook than an earlier leaked draft had suggested.
The French report sent a message to new French President François Hollande that his growth agenda faces severe constraints.
Hollande wants to shift Europe's strategy towards growth and ease the pace of German-led austerity some economists blame for suffocating national economies, but France's ability to meet its goals is crucial to the euro zone's credibility with investors.
"The distance to the 3 percent of GDP threshold remains significant," the Commission said in its annual assessment of France's economic performance, saying budget consolidation was one of France's biggest policy challenges. "Correcting the excessive deficit by 2013 may require additional efforts."
Good news for Viktor Orbán
Meanwhile Hungary’s inclusion on the list was tempered by a Commission call for it to be given back access to half a billion euros in frozen development aid as a reward for tackling its budget deficit, paving the way for EU finance ministers to end sanctions next month.
Finance chiefs blocked the €495 million in EU funds in March to punish Budapest for failing to rein in its deficit in a sustainable manner since it joined the EU in 2004, but a quick resolution would mark a victory for Prime Minister Viktor Orbán.
It would also be the latest sign of a thawing of the tensions with Brussels that have blocked talks on emergency financial aid to prop up Hungary's financial markets and keep its borrowing costs under control.
The forint surged after Commission President José Manuel Barroso's comments at a news conference.
"We are ... recommending that the suspension of the cohesion fund allocation for Hungary is lifted, as they have now taken the necessary action to correct its excessive deficit," Barroso said.