EU Criticized for 'Pretend and Extend' as it Eases Austerity

Brussels's softening stance on austerity with stability and growth measures delayed for another two years is an exercise in "pretend and extend" and what's really needed is urgent structural reforms, analysts have told CNBC.

The European Commission, which released its verdict on the health of the EU's 27 member states on Wednesday, said Poland, France, Slovenia and Spain would be given two more years to reach the mandatory 3 percent budget deficit target.

The director general of the World Trade Organization, Pascal Lamy said he expected the EU to focus on structural reforms over fiscal restraint.

(Read More: French Charm Offensive: Too Little, Too Late?)

But some analysts reacted with frustration at the idea of another extension of the European Commission's (EC) stability and growth deadlines.

"The fact is that Spain has promised to be at 3 percent [budget deficit target] on my count for 5 years running now. The banking sector is still stretched and needs new capital. We need to have the stability and growth enacted and enforced, what we are seeing now is a delay of another two years, if that is not pretend and extend then I don't know what is," said Steen Jakobsen, chief economist at Saxo Bank.

Jakobsen said the EC's leniency was the true definition of Albert Einstein's idiom on insanity, where European economies are allowed to do the same experiment over and over again and expected to deliver different results.

(Read More: Reinhart, Rogoff: Austerity Is Not the Only Answer)

A dramatic overhaul of European fiscal and monetary policy in favor of small and medium size enterprises (SMEs) is needed he said, as they will be the real drivers of growth.

Patrick Legland, head of research at Société Générale said despite virtually no improvement in the European economy in the last year, Europe was close to meeting its budget deficit targets.

"There has been virtually no improvement. What has maybe changed is the framework, because at the end of 2013, the budget deficit in Europe will be at 2.9 or 3 [percent of GDP], which on one side on a consolidated basis, is mission accomplished for Europe – because budget deficit has improved," said Legland.

(Read More: 'Recessions Hurt, but Austerity Kills': Study)

"Where they have failed, is debt as a percentage of GDP is still going up – even in Germany debt is going up," he added.

Legland also agreed that the focus should shift to helping SMEs gain access to credit.

"I agree that SMEs are the key of the European economy. At this stage the transmission of the ECB policy doesn't work. Its short term interest rates are still relatively high and this is punishing for SMEs in Europe. While this lasts it will be very complicated for SMEs to restart to invest, particularly in peripherals," said Legland.

Nicholas Spiro, managing director of Spiro Sovereign Strategy said the fierce backlash against austerity had chipped away at the credibility of other parts of the European Commission's reform agenda.

(Read More: Europe's Austerity Era Could Be Coming to an End)

"The reality is that the tide has turned decisively against the entire economic reform drive in the eurozone. If Brussels thinks that the liberalization of labor and product markets are somehow insulated from the anti-reform backlash across the bloc's periphery and in parts of the core, it has another thing coming," said Spiro.

"France is the test case of the Commission's new approach - a worrying prospect given that the lack of structural reform in France has been one of the eurozone economy's biggest Achilles heels for some time," he added.

By CNBC's Jenny Cosgrave; Follow her on Twitter @jenny_cosgrave.