Inteligencia y Seguridad Frente Externo En Profundidad Economia y Finanzas Transparencia
  En Parrilla Medio Ambiente Sociedad High Tech Contacto
Economia y Finanzas  
  Significance: Deep recession has exposed fault lines within the Eurozone. These had previously been partly covered up—or maybe more accurately, pushed into the background—by reasonable growth across the Eurozone, housing/construction-led robust expansion in Spain and Ireland, and inaccurate/creative government accounting in Greece.

09/02/2010 | Future of Eurozone Questioned as Greek Woes Deepen and Spread

Global Insight Staff

Greece's high budget deficit and debt levels have fuelled concerns about the country's creditworthiness; these concerns have spread to other countries—notably Spain, Portugal, Ireland, and Italy—and have even led to some speculation that one or more country could end up leaving the Eurozone.

 

IHS Global Insight Perspective

Implications: The possibility of Greece and/or other countries leaving the Eurozone is increasingly being taken seriously. IHS Global Insight considers this unlikely, but the prospect cannot be completely dismissed.

Outlook: We believe that at as a last resort other Eurozone countries would bail out Greece, but under very strict conditions.

Deep economic recession has exposed serious fault lines within the Eurozone that will require major corrective action over both the short term and further ahead. Failure to take such action would threaten the very existence of the Eurozone in its current make-up, and there is growing talk that one or more countries could even end up leaving the single currency.

The trigger for the current heightened tensions within the Eurozone has been the plight of Greece, following revelations that its fiscal deficit is substantially higher than previously reported. Meanwhile, markets have fundamentally reappraised risk as central banks have looked to start unwinding the various emergency measures that were introduced when the recession was at its deepest and financial market dislocation was compounding problems. Consequently, markets have come to the conclusion that the risk spreads of the "Club Med" countries (Spain, Portugal, Greece, and Italy) and Ireland had converged far more with German bunds than was justified by economic fundamentals.

Structural problems in these countries (given the group name PIIGS) had been pushed into the background—or even partly covered up—by reasonable, if hardly spectacular, average GDP growth of 2.1% across the Eurozone during 1999–2008. In addition, Spain (average growth of 3.5%) and Ireland (5.6%) had substantially outperformed the Eurozone as a whole during this period as their growth was lifted by housing and construction booms fuelled by cheap credit. Greek growth had also been an above-average 3.9% during 1999–2008, boosted by structural funds, while false accounting had covered up the extent of its fiscal woes.

However, the recession and sharply deteriorating budget deficits have unearthed the structural problems of Spain, Ireland, Portugal, and Greece. In addition, Italy has also been caught up in the turmoil, albeit to a lesser degree so far, reflecting its long-term under-performance and high debt levels (although it has kept its budget deficit relatively tight during the recession). These structural problems primarily stem from these countries' lack of competitiveness caused by above-average wage and total labour cost increases during the past 10 years, as well as low productivity growth, and are reflected in large trade deficits. Their problems have been compounded by a strong euro in recent years and the sharply increased competitiveness of Germany.

Indeed, the Eurozone's imbalances have been heightened by Germany's reliance on export growth and lack of domestic consumption. This has resulted in substantial German trade surpluses vis-à-vis other Eurozone countries. Whereas in the past, devaluation of their currencies would have eased the problems for Greece, Spain, Ireland, Portugal, and Italy, this option is closed to them as members of the Eurozone.

Eurozone Markets Hammered

Contagion has seen investor concerns over Greece spread to Portugal and Spain, pushing up the cost of insuring their government debt to record highs. Indeed, the spread of a number of Eurozone countries' bonds against German bunds has widened, indicating increased tensions within the bloc. In addition, Eurozone equity markets have suffered substantial sell-offs, while the euro retreated to a near nine-month low under 1 euro:US$1.36 earlier this month, compared with a high of 1 euro:US$1.5145 in late November 2009 (although this, at least, is actually a welcome development for Eurozone growth prospects).

Investor concerns are being heightened by the perception that the Eurozone has not got any contingency measures in place to deal with a country in Greece's position and at real risk of defaulting. Indeed, the Maastricht Treaty rules contain a "no bailout" clause, which was aimed at ensuring that a member country's budgetary problems could not spill over and damage the credit rating of the Eurozone as a whole. However, there is a belief that the Eurozone could get round this by invoking Article 122 of the Lisbon Treaty (Reform Treaty), which allows European Union (EU) financial assistance to be given to a member country in difficulty.

Outlook and Implications

Ultimately, despite the brinkmanship of Germany, in particular, and concerns over "moral hazard", IHS Global Insight believes that the other Eurozone members will do whatever is necessary to save Greece. This could take the form of a special loan, perhaps financed by a Eurobond. There is massive substantial political capital invested in the Eurozone, and this is likely to prove the determining factor. Eurozone countries may also well be reluctant for Greece to seek help from the International Monetary Fund (IMF) because of concerns that this would be seen as a sign that the single currency area cannot sort out its own problems. The conditions of an IMF loan package could directly undermine the monetary authority of the European Central Bank (ECB) in its sphere of responsibility. The ECB has orchestrated quite successful loan and swap support packages for Eastern Europe (Hungary, Romania, Latvia) over the last two years that have achieved a degree of stabilisation in these host countries; it should be capable of doing the same for a Eurozone country.

The danger is that if Greece were to leave the Eurozone, a precedent would be set and attention would immediately focus on the next candidate to leave or be forced out. This would be massively destabilising for the single currency area.

Furthermore, leaving the Eurozone would be extremely difficult both logistically and in economic terms for a country, and there is no guarantee that in the long run it would be better off than staying within the single currency area. The main advantage that a country leaving the Eurozone would have is that its currency would devalue substantially and improve its competitiveness, while policy interest rates could be cut (although, of course, at the moment they are very low anyway). However, there would undoubtedly be an immediate mass exodus of capital from the country and long-term interest rates would be highly likely to rise appreciably. All debt denominated in euro would spike sharply higher as the new currency devalued and the likelihood of default jumped. Moreover, if Greece were to default outside the Eurozone, there would be major long-term political and economic repercussions.

Any help for Greece from the other Eurozone countries though would undoubtedly come at a very steep cost in terms of corrective steps that must be taken and heavy supervision. Indeed, there is already evidence of this, with the European Commission this month approving the Greek government's plans to bring its budget deficit down from 12.7% of GDP in 2009 to 8.7% of GDP in 2010 and 2.8% in 2012 on condition that further major fiscal measures are taken and that the government supplies regular reports on the progress being made in bringing the deficit down.From the point of view of other Eurozone countries, be it from the PIIGS group or the remainder including Germany, such a procedure allows much better control and ultimately should come at a much lower cost for them than if they permitted market pressure to force an exit of Greece from the Eurozone and/or bring about a Greek default.

So far, the Greek government has announced substantial fiscal tightening measures involving both swingeing spending cuts and tax hikes, but the lack of clarity on how the ambitious targets will be achieved, combined with the weak fiscal credibility of the Greek government, means that there is still huge uncertainty about the country's ability to achieve the necessary adjustment amid probable major public unrest.

In many respects, Ireland has already swallowed some very nasty fiscal medicine and appears—at least for now—to have alleviated market concern about the danger that it could default.

A significant concern is that tension within the Eurozone could mount as disillusioned voters in struggling economies watch their governments surrender their fiscal policy options in order to reduce their budget deficits below 3% of GDP by 2013. With no control over interest and exchange rates, and given the need to operate within very tight fiscal restraints, the recovery could be slow and laboured in Italy, Spain, and others. This could condemn several countries to endure recessions with very long tails.

Problems Will Recur Until Fault Lines are Fixed

However, even if Greece is rescued and the pressure on it, Spain, Portugal, Ireland, and Italy wanes in the near term, the Eurozone will be prone to persistent tensions until the major fault lines are repaired.

In fact, it could be argued that Spain presents the most serious long-term risk to the Eurozone, given that it accounts for some 11.5% of the region's real total GDP, as opposed to Greece's share of 2.5%. Although Spain's immediate public finance problems are not as problematical as Greece's, there are serious concerns over Spain's longer-term economic outlook given that it faces an unemployment rate of close to 20%, high consumer debt levels, and a need to rebalance away from the construction sector.

Given that Eurozone member countries cannot devalue their currencies or follow separate monetary policies, and have limited scope for major fiscal action, the divergences between them in terms of wage costs and productivity must be narrowed to limit future pressure points. Ireland is currently implementing wage cuts in both the public and private sector, and cuts in real wages need to occur in Spain, Portugal, and even Italy, as well as in Greece. Germany, of course, underwent a major period of wage restraint during 2002–07, which has substantially boosted its competitiveness. Although a fall in wage costs is imperative, the lengthy disinflationary process the PIIGS countries need to experience in order to regain their competitiveness is likely to weigh down on their rate of nominal GDP growth, resulting in a deterioration of the debt-to-GDP ratio.

However, this extended squeeze on workers is now clearly a factor in German consumers' unwillingness to spend. Indeed, another required development that is key to the future stability of the Eurozone is for German domestic demand to improve and for the country to import from other Eurozone members so that trade imbalances within the single currency area diminish.

Currency unions without full political union (which is clearly unthinkable in the case of the Eurozone) will always be prone to strains, particularly when the overall economic environment is troublesome. Moreover, these strains will be deeper the more divergent the economies are, particularly in terms of competitiveness. If the Eurozone is to survive over the long term, these divergences must be addressed—or at the very least the Eurozone will be liable to haemorrhage members.

It can also be argued that the European Commission has been too lax towards some countries maintaining excessively high public debt (gross general government debt levels) since the inception of the euro. Several countries have been allowed to keep their debt levels well above the 60% target, exposing their vulnerability in the wake of the global and economic crisis. We could see the Commission placing more pressure on governments to implement more effective debt consolidation programmes after the situation has normalised. In addition, like it or not, the Eurozone needs to develop and put in place a robust, formal mechanism for dealing with crises, such as that currently being experienced by Greece.

Our view is that political commitment to the Eurozone means that other member countries will help Greece through this crisis, and that it will stay within the single currency area. However, structural problems in the least competitive countries must be addressed, or else it will only be a matter of time before the next crisis arrives.

Global Insight (Reino Unido)

 


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