A Collective Sigh of Relief - Deloitte

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Global Economic Outlook 2nd Quarter 2012 8 In the short term, growth prospects for the Eurozone look better than many feared in the beginning of the year when a severe recession was widely expected. Decision 2. Signing the fiscal compact The treaty on stability, coordination, and governance — the fiscal compact — was signed by 25 of the 27 EU leaders as an intergovernmental agreement; the United Kingdom and the Czech Republic did not join. The key point of the treaty is a balanced budget rule, which mandates that annual structural budget deficits cannot exceed 0.5 percent of GDP. The rule must be incorporated into national law, preferably at the constitutional level. The EU Court of Justice will oversee the rule’s transposition and will have the power to impose severe sanctions. Promoted by Germany and other northern European governments, the rule is supposed to prevent unsustainable future government debt. The fiscal compact is intended to significantly constrain government spending in the future. Whether or not it will solidify public finances will depend on its implementation and therefore on politics at both the national and European levels. Decision 3. Restructuring Greek private debt Finally realizing that it has taken on more debt than it can realistically ever expect to pay back, Greece undertook the biggest sovereign-debt restructuring in history. It is the first time in six decades that a developed country has defaulted on its debt. Technically, private investors will receive new government bonds with long maturities, which amount to a loss of 53.5 percent. Some 86 percent of Greece’s private debtors agreed to participate in the €206 billion bond swap. Through the use of collective action clauses, the government will force reluctant investors who own bonds to participate in the swap under Greek law. The program decreases Greek debt by €100 billion. As a result, Greek debt — currently 164 percent of GDP — is supposed to stand at 120 percent of GDP by 2020. After the successful swap, the European Union agreed to a second bailout package, which amounts to €130 billion in credits until 2014. While the acceptance of the bond swap by private investors averted the threat of an uncontrolled default, two uncertainties remain. The first is whether the goal of a 120 percent debt-to-GDP ratio can be achieved. Given that the Greek economy is shrinking far more than expected, this is questionable. The second is that 120 percent of GDP still amounts to an enormous mountain of debt, and there are many doubts that the Greek economy will be able kickstart itself again while laboring under this burden. Decision 4. Reforming Italy and Spain Meanwhile, Italy and Spain — two large Eurozone economies that were endangered last year — are introducing substantial economic reforms. The Italian technocratic government, headed by Mario Monti, redesigned Italy’s pension system, increased the retirement age, and is opening sheltered sectors. The government also plans to liberalize employment protection. Spain’s new conservative government is reforming its labor market by introducing greater flexibility in a system that is characterized by a two-tier structure. Older employees with unlimited contracts enjoy a high degree of protection, while younger employees tend to be on limited contracts. This is one of the key factors contributing to the huge social problem of the youth unemployment rate in Spain, which now stands at an unprecedented 51 percent. This fact raises the question of whether or not these austerity programs are sustainable in a political sense. The programs introduce short-term pain for large parts of the population while promising gains mainly in the long term. This could lead to a circle of austerity fatigue in the population, lobby group pressure, and protests, which can become an explosive combination. Radical parties opposed to austerity and reform policies might become stronger in elections, along with an increasing appetite for change in government. Since the beginning of the Euro crisis, governments have changed with remarkable frequency. Examples include Greece, Italy, Ireland, Portugal, and Spain. So far, changes in government have not worked against the reform programs. Nevertheless, the implementation of reform programs faces serious political risks. The short-term outlook is two-tiered In the short term, growth prospects for the Eurozone look better than many feared in the beginning of the year when a severe recession was widely expected. Looking back, the Eurozone as a whole achieved a growth rate of
Figure 2. Economic Sentiment Indicator 120 100 80 60 40 20 1.4 percent in 2011. In the last quarter of 2011, it experienced a negative growth of 0.3 percent. The European Commission expects a negative growth rate of 0.3 percent for the Eurozone in 2012, with a recovery of growth in the second half of the year. Current expectations, measured by the Economic Sentiment Indicator (ESI), are moderately optimistic. Economic sentiment is still considerably below its long-term average of 100, but it is recovering nonetheless (see figure 2). The ESI rose for a second consecutive month in February to 94.5, before decreasing by a marginal 0.1 points in March. Beneath the surface, however, developments point to deepening growth differentials in the Eurozone. While Germany’s ESI stands at 104, the expectations for troubled Eurozone economies are still grim. Spain’s ESI is 91, Italy’s is 89, and Greece’s is 76. Germany’s situation is mirrored in the results of Deloitte Germany’s first CFO survey. German CFOs feel that macroeconomic and financial market uncertainty is unusually high. They are also highly doubtful about the current and Eurozone 0 Jan ’07 Jan ’08 Jan ’09 Jan ’10 Jan ’11 Jan ’12 Source: European Commission future stability of the Eurozone as well as the effectiveness of the Eurozone’s political crisis management. However, they show moderate optimism when it comes to their own business outlooks. Growth differentials and two-tiered economic performance are dangerous because they reinforce the substantial difference in competitiveness between Eurozone nations. While the European Monetary Union was meant to lead to convergence in economic performance, the reverse has actually occurred, and economic performance and expectations continue to diverge. Neither growth patterns nor unit labor costs, one of the main indicators for competitiveness, have shown convergence in the Eurozone in the last decade (see figures 3 and 4). Greece: Too much debt, not enough growth Until a few years ago, Greece was one of the fastestgrowing European economies. From 2001 to 2007, its GDP grew on average by 4.1 percent per year. The Eurozone as a whole grew by 2 percent, and Germany grew by only 1.4 percent. As it turned out, after the financial crisis, this Geographies Germany France Euro area Spain Italy Greece 9
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