12. May 2017 Scope research – Sovereign
Euro area: at a turning point
The euro area is broadly recovering, yet legacy of the crisis remains. However, the euro area architecture is more resilient than commonly recognised. Challenges facing government’s finances stem from political risks and high debt levels.
While the economies in the euro area have been recovering since 2014, with Scope expecting real GDP to grow on average by 1.7% in 2017 and 2018, the legacy of the financial crisis continues to present challenges: high public debt, economic and social malaise, and more recently, intensified political risk. It is Scope’s view that while the fundamentals of the euro area are stronger than recognised, a still-fragile economic growth environment and an ageing population will make it challenging for euro area sovereigns to grow out of high levels of public debt.
“The resilience of the euro area has improved much more in the course of the crisis than commonly recognized” says Dr Giacomo Barisone, head of the public finance group at Scope and one of the authors of the special comment. “In addition to a more activist role of the ECB, important achievements, such as the establishment of the European Stability Mechanism, the banking union, the creation of a new macro-prudential framework with a strong single supervisory mechanism, together with the new macroeconomic surveillance, have all been decisive steps towards a more robust euro area architecture, substantially reducing euro area credit risk in times of shocks”, he adds.
Nevertheless, a substantial trend change towards declining public debt ratios can only be expected if the current economic recovery continues to broaden, supported by a reflationary, low interest rate environment. The ECB’s unconventional monetary policy mix has helped to stabilise financial markets and support the economy. However, risk aversion, which has led to conservative lending after the crisis, as well as incomplete repair of the banking sector, continues to hinder cross-border lending and investment within the euro area.
The ECB’s liquidity generation is unprecedented, as well as its ‘interference’ in European bond markets through its Asset Purchase Programme (APP). Scope acknowledges that a return to ‘normal’ will take time and comprise risk for financial markets and the economy. Even in a low interest rate environment, highly indebted countries continue to be limited in their ability to pursue fiscal stimulus due to ongoing high interest payments. There is also limited policy space to cope with adverse shocks.
Several years of job losses and economic malaise have eroded confidence in not only the European, but also the global economic model. This has led to an increase in political risk. The rise of anti-establishment political forces in the wake of this backlash complicates any consensus-based reforms and puts fiscal consolidation at risk.
Further implementation of European policy initiatives, as well as country-level reforms to enable a more balanced and dynamic economic recovery, remain substantial challenges. The euro area’s future and risks may be less dependent on the actual degree of integration and more on concrete policies and institutional arrangements designed to ensure the euro’s success, especially in difficult times.
Download the full report: Euro Area: At a Turning Point.
Analyst Conference Call
Scope's Public Finance analysts will discuss the special comment on the euro area in a telephone and web conference call on Wednesday, 17 May 2017, at 3:00 pm CET. Following a brief presentation, Scope analysts will be available to take questions.
When: Wednesday, 17 May 2017, 3:00 pm CET
How: Conference call and web presentation
Analysts: Giacomo Barisone, John Opie
Click here to register
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