Fiscal emergency to recession – counting the cost of the Greek crisis
Fiscal crisis in the euro-zone has followed the banking crisis, fitting the typical historical pattern, and we estimate the resultant budget cuts will force several member states back into recession. These cuts are the ‘other side of the coin’ of the recent rescue plan assembled in response to the Greek crisis. While the euro-zone economy as whole will probably sustain some growth, headlines are likely to be dominated over the coming year by stagnation and recession affecting individual member states. This provides a negative background for the euro and assets of those countries most negatively affected, including equities and property. But some companies and economies will benefit from the increased export competitiveness that euro weakness brings.
European policymakers finally got ‘ahead of the curve’ with a €750bn rescue package on 9th May, extending support to any euro-zone member facing difficulty financing its debt. However, this package was designed to address liquidity problems that threatened to disrupt financial markets, particularly the fragile banking sector. It does not address the fundamental solvency issue of ‘sinner’ member states with excessive budget deficits and/or accumulated debts. Euro-zone governments, led by Germany, demanded that member states take steps to address these problems through fiscal consolidation.
Spain and Portugal have both announced new budget measures, including pay cuts for civil servants. Greece has announced a succession of measures as part of its earlier rescue package, while Ireland’s budget last year incorporated cuts in pay and benefits, including a 20% pay cut for the Prime Minister. Fiscal consolidation won’t be confined to just the ‘sinners,’ as practically all countries are facing structural deficits in the aftermath of the financial crisis and recession of 2008/9. Germany, for example, has announced plans to cut its deficit by €10bn.
Obviously, cutting spending in the midst of a weak recovery will reduce economic activity. Our estimates of the impact, set out in the table below, are based on assumptions about the extent of budget cuts this year and their impact on economic growth. These estimates, set against Consensus Economics forecasts made prior to the crisis and announcement of these cuts, show most of the ‘sinner’ countries falling back into recession this year. We could be wrong about the timing, as some of the impact will be felt in 2011. We estimate that the euro-zone as a whole avoids a double-dip recession, though there are likely to be a very modest levels of growth or stagnation.
An interconnected global economy means that lower growth for the euro-zone will have knock-on effects. However, our estimate is that the drag from the euro-zone will cut less than half a percent from global growth and not derail recovery. Euro-zone countries with significant exports to emerging economies with strong growth, such as China, will benefit from the fall in the euro. Relative to the rest of the euro-zone, we remain positive on the outlook for the shares of well-positioned exporters and multi-nationals in countries such as Germany.
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