Euphoria over Europe
The threat of the eurozone splintering has receded for now. But questions over Europe’s social policies are only one terrorist incident away
British Prime Minister Theresa May has landed herself in a political soup just as her predecessor did. For the second year running, the British Conservative Party has plucked defeat from the jaws of victory. Having won a comfortable election victory, David Cameron called for a referendum on Britain’s membership in the European Union (EU) last year and had to resign when the British public voted to leave the union. May replaced him. She called for a national election in April hoping to win a strengthened mandate for her to negotiate with the EU. She had earlier triggered the process for leaving the EU.
She ran a lacklustre campaign. In particular, her decision to remove some old-age pension entitlements did not go down well with her party’s main vote bank—the elderly. The youth had sided with the agenda of multiculturalism, pro-immigration, pro-welfare and pro-national ownership of infrastructure industries put forward by the Labour Party. On 9 June, when the election results were announced, the Conservative Party found out that it had lost whatever little majority it had in the House of Commons. Now, it is about or eight seats short of the 326 required to form a government of its own. The Labour Party had gained 30 seats to increase its tally to 261 seats.
May has staked her claim to form the government as the leader of the single-largest party. But her authority has been weakened considerably. EU leaders were playing hardball with Britain even before the election results. Now, they would be even less inclined to be accommodative.
Further, the eurozone has become a region of economic stability, at least superficially. German Chancellor Angela Merkel, for better or worse, has regained her poise and composure after facing some domestic political backlash for her refugee policy in 2016. Although news continues to dribble out of Germany that violent crimes in its small towns and villages has gone up, recent local election results in the country have gone in her favour. Further, the election of Emmanuel Macron as French president has boosted morale in the eurozone. Between them, they appear poised to move towards closer European integration in the years ahead.
The threat of the eurozone splintering has receded for now. But questions over Europe’s social policies are only one terrorist incident away. Further, while unemployment rates in Italy, Spain and Greece have declined in the last one-two years, they remain high and well above the pre-2008 crisis lows. The Italian unemployment rate is 11.1%. Spain’s rate is 18.8% and that of Greece, above 23%.
There is no consensus on whether European banks have solved their problems. It shows up in the credit growth, or more precisely the lack of it, in eurozone countries. Actual credit/gross domestic product (GDP) versus the trend in Spain, Italy, Portugal, Greece and even Germany shows that the credit gap is negative. That is, the credit/GDP ratio is running below trend. The gap is huge for Spain and Portugal, and somewhat less so for Italy and Greece, but still negative.
Importantly, it is not as though credit growth is running slow but positive. We examined the data on credit to the non-financial private sector for the key peripheral countries—Italy, Spain, Portugal and Greece—more closely. Actual credit/GDP ratio has declined over the years and it is because the numerator—credit to the non-financial sector—has declined. In a way, it raises questions as to the purpose and effectiveness of the policy of asset purchases by the European Central Bank (ECB). What the asset purchases have done is to inflate asset prices without boosting lending to the non-financial private sector (businesses and households) in the real economy.
At the same time, government borrowing has picked up. The ECB’s bond buying has artificially lowered the cost of capital (yields) on government bonds and enabled governments to accumulate further debt. Spain and Portugal have missed their fiscal deficit targets and their debt/GDP ratios have been on the higher side.
In the case of Spain, the general government debt/GDP ratio was 86.2% at the end of 2012. At the end of 2016, it had ballooned to 112.2%. For Portugal, the debt ratio was 126.2% in 2012 and by the end of 2016, it had risen to 138.1%. For Italy, the numbers are far more concerning. The debt ratio stood at 151.3% in 2016 versus 130.7% in 2012. Both Spain and Portugal were spared fines for missing their deficit targets last year.
The ECB, in its monthly meeting on 8 June, dropped a reference to further lower rates (negative), a possibility that it had held out for a long time. This is a minor concession to the sentiment in Germany, which has grown increasingly uncomfortable with eurozone monetary policy. Asset purchases by the ECB are set to continue into 2018 under the current plan but Germany might exert pressure on an earlier termination. The ECB alone has added €530 billion to its assets in the first five months of the year. The future of eurozone peripheral nations’ bond yields, once ECB support is withdrawn, might not be bright. Underlying fiscal fundamentals have barely improved.
European stocks are not as egregiously valued as American stocks. Nonetheless, it is hard to see how one could or should load up on eurozone stocks on the assumption that good news is yet to come.
V. Anantha Nageswaran is senior adjunct fellow (geoeconomics studies) at Gateway House: Indian Council on Global Relations, Mumbai. These are his personal views.
Read Anantha’s Mint columns at www.livemint.com/baretalk.
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