Eurozone is still vulnerable to rise in interest rates
EU Spain Portugal Greece Cyprus Ireland
THE EUROZONE is not in good shape: growth is close to zero, unemployment is high, and some countries remain vulnerable to how the business cycle could affect the sustainability of their public debt. Some European countries could sink triggering a domino-effect throughout the entire eurozone, writes World Review expert Professor Enrico Colombatto.
The response by the European authorities has been effective in the past. Critical situations in five countries – Spain, Ireland, Greece, Portugal and Cyprus – have been neutralised by launching five bailout programmes which have calmed the financial community.
The result is that the public now believes that since these programmes worked relatively well in the past, they will be launched again if the need arises in the future.
But are these hopes well founded and is the bailout strategy a suitable recipe for future crises?
So what happened last time round? It was clear towards the end of 2010 that the public-finance situation in a number of eurozone countries had become hopeless. In some cases, public debt had got out of control because of structural mismanagement.
This was true for Greece, but also for Spain and Portugal, where the governments’ spending was systematically much greater than tax revenues.
In other countries, the problem originated from the political response to a major event or accident. A primary example is Ireland, where the explosion of the property bubble put the banking system on the verge of collapse, and the government decided to shore up the banks involved.
To avoid a sovereign-debt crisis – with the potential for a dramatic domino effect – the European Union and the International Monetary Fund agreed in 2011 to make low-cost loans available to troubled countries.
The beneficiaries were required in return to follow the budgetary instructions from the EU and IMF and bring about a list of structural reforms they suggested as the lenders.
The loans were called bailout programmes and each programme covers the period during which the various instalments or tranches are handed out to the borrower. New tranches are distributed as long as the borrowing country meets the bailout reforms demanded by the lenders. Failure to comply involves an extension of the bailout programme.
Ireland was the first country to exit the bailout programme in December 2013. The future for Ireland looks encouraging.
Growth remains weak in Portugal and unemployment is 13 per cent, and 35 per cent among the young.
Spain is a little better but unemployment is dramatic at 24 per cent overall, and 54 per cent among the young.
Cyprus is still in trouble with recession, high unemployment and problematic public accounts.
Preliminary conclusions are straightforward – Ireland, Spain and Portugal did not need the bailout programme because they were on the verge of structural bankruptcy but because they needed low interest rates.
The best way of lowering interest rates on their public debt some four years ago was by telling markets that powerful friends had given them all the liquidity they needed.
As the EU and the IMF both approved these countries’ virtuous behaviour, markets now believe that these three economies will be bailed out again, if necessary.
The Greek context is different. Greece was planning to leave its second bailout programme by the end of 2014, but this is being delayed for ‘technical reasons’. The key issue is that the EU and IMF have objections to the Greek 2015 budget.
If the Greek government fails to comply to EU demands, the last tranche of the bailout loan will not be given. The Greeks need the money pretty badly and stand no chance of raising it on the market.
Greece is a hopeless case and will soon need another bailout package.
EU countries involved in bailout programmes are still vulnerable – with the exceptions of Ireland which is safe and Greece which is hopeless. The key is the cost of debt-servicing.
Spain, Portugal and Cyprus are highly dependent on what happens to market interest rates. If these stay put, other bailouts will be unnecessary. If rates rise, and growth does not speed up, bailouts will not be enough to ease the cost of debt-servicing. Debt-restructuring will be inevitable.
If that happens heavier debt servicing will mean big trouble for eurozone heavyweights France and Italy.
Future bailouts will have little in common with the past when these loans helped troubled economies to placate markets and recover low-interest rate conditions. Bailouts will be equivalent to debt monetisation in a context of higher market interest rates.