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By Paul Taylor
PARIS, Dec 02 (Reuters) – The euro zone is in the recovery
room now the danger of a Greek default has been averted for a
couple of years, but it is not yet safe from a Japanese-style
“lost decade”.
The currency area’s escape route hinges more on the pace of
expansion in the United States and China, lifting the world
economy, than on the policy mix in Europe, which will continue
to favour austerity over growth in 2013.
At best, Ireland and Portugal could emerge slimmed down from
their bailout programmes and regain capital market access by the
end of the year, demonstrating that adherence to a tough fiscal
adjustment plan can work.
But question marks hang over both. And Greece, like
miracles, will take a little longer. And another debt writedown.
Gloomy forecasts from the OECD and private economists
suggest the 17-nation euro currency area may stay in recession
all next year, swelling the armies of unemployed and pushing
efforts to reduce public deficits and debt mountains off track.
Political risks abound; possible social revolt against
austerity policies in Greece, Spain or Portugal; a messy,
inconclusive election outcome in Italy; and perhaps labour
unrest against more modest structural reforms being mooted in
France.
Monday’s EU-IMF agreement to keep Greece afloat inside the
euro zone, by reducing its debt now and hinting at official debt
relief to come later, has removed the biggest risk of a
financial shock that could re-ignite market panic and send the
euro back into the emergency ward.
Market relief over the Greek deal, coupled with European
Central Bank promises to do what it takes to preserve the euro,
helped Italy sell its last 10-year bonds of 2012 on Thursday at
the lowest yield for nearly two years.
French Finance Minister Pierre Moscovici called it “a
turning point for the euro zone because it helps recreate
stability and confidence. Greece’s fate will no longer be a
daily issue”.
European Internal Market Commissioner Michel Barnier, using
a soccer metaphor, said the peak of the debt crisis was over and
“we are now at the start of the second half”.
Some analysts are less convinced.
Mujtaba Rahman of Eurasia Group said the Greek fix “keeps
the show on the road, but is no game changer”.
GERMAN DELAY
The campaign for Germany’s general election in September
means that bolder steps towards writing off debt or sharing
liabilities will have to wait until at least the end of next
year. Public opposition to a “transfer union” in the euro zone’s
biggest economy and main paymaster remains high.
Yet no Eurosceptical party has emerged to capitalise on that
mood, and the next Berlin government, whether a “grand
coalition” of centre-right and centre-left, which seems the most
likely, or another permutation, may be more open to such
solutions.
The European Commission set out ambitious proposals for
closer economic, fiscal and banking union last week, including a
common euro zone fund to reward structural reforms, but most big
changes will be on hold until after the German vote.
In the meantime, modest progress is likely on creating a
single European banking supervisor, the first step towards a
euro zone banking union, but without a joint deposit guarantee
to deter capital flight and bank runs.
IMF Managing Director Christine Lagarde says swift
implementation of a banking union with powers to supervise all
banks in the euro area is now the top priority.
Germany will continue to press for stricter European control
over budgets in euro zone states, but that will involve
trade-offs with greater mutualisation of risk and treaty changes
that might only come after the 2014 European Parliament
elections.
Many EU officials and analysts expect that Spain, which has
so far avoided a sovereign bailout, will have to request euro
zone assistance early in the new year, when it needs to raise at
least 230 billion euros ($300 billion) on capital markets.
That would trigger European Central Bank buying of its
bonds, which might reassure investors and further reduce
borrowing costs for Madrid and Italy initially.
But it would raise hackles in Germany, given the
Bundesbank’s continued opposition, prompting market speculation
about the ECB’s will and ability to sustain bond purchases.
Markus Huber, senior trader at ETXCapital, reckons that even
though economic reforms and ECB reassurance have cut Italy’s
borrowing costs, an indecisive outcome of a general election due
in April could send yields soaring again.
Rome is also at risk of contagion if Spanish Prime Minister
Mariano Rajoy continues to dither and delay a euro zone credit
line for Madrid, he said.
FRANCE RISK?
A more remote but much-talked-about risk is the possibility
that financial markets could turn against France if President
Francois Hollande’s labour market and welfare financing reforms
disappoint or meet militant street resistance.
France’s borrowing costs are hovering close to historic lows
despite its loss of the coveted AAA credit rating from Moody’s
this month after Standard & Poor’s downgraded Paris in January.
Fitch Ratings, the only credit watchdog still to have France
on AAA, said last week it could lower that grade if the country
fails to meets its deficit reduction targets and its economy
performs worse than forecast.
Yet many investors believe France, with a deep, liquid debt
market, enjoys an implicit German guarantee and so buy French
bonds as a proxy for the strong northern euro zone states that
have less debt to issue.
French economist Jacques Delpla, co-author of a proposal for
a limited issuance of common euro zone bonds, argues that euro
states’ debt will become more attractive in the next few years
as other major economies try to inflate away their problems.
“The whole of the world except Europe is going to inflate
away its debt – the United States, Britain, Japan,” he told a
conference of the European Council on Foreign Relations.
“Only euro zone debt will remain strong blue debt because
the great German legacy is that we won’t inflate. So part of our
debt is going to default, and the rest will become the crown
jewels of world debt.”
In economic terms, the euro zone’s adjustment should advance
further next year, with German wages rising above inflation
while “internal devaluations” in peripheral euro zone countries
make their exports more competitive and narrow current account
imbalances.
ECB President Mario Draghi, who expects most of the euro
zone to start recovering in the second half of 2013, cautioned
on Friday that the crisis was far from over and governments must
consolidate their budgets and reduce current account imbalances.
Optimists such as the Lisbon Council, a Brussels-based
pro-market think-tank, and Berenberg Bank say the euro zone is
turning into a more balanced and potentially more dynamic
economy thanks to market pressure and constant demand for
structural reforms.
But the longer and deeper the recession in Spain, Italy and
Portugal, the greater the risk of them being sucked into a
vicious circle of falling revenues outpacing spending cuts which
in turn depress demand and output, causing lower revenues.
At the gloomy end of the scale, economists from Citi said
last week they expected continued recession in the euro area in
2013 and 2014 and prolonged weakness thereafter – with ongoing
financial strains and, over the next few years, a Greek exit and
a series of sovereign debt restructurings.
The euro’s survival may no longer be in much doubt after the
ECB stepped in and the Germans decided to keep Greece inside the
currency area, but the euro zone faces at best a slow grind back
up the hill.
($1 = 0.7705 euros)
(Additional reporting by Lisa Jucca in Milan; Writing by Paul
Taylor; Editing by Will Waterman)
