European economies inspire little confidence of growth

GREECE took over the presidency of the European Union for six months in January 2014 thanks to the financial support it has received from two huge financial bailouts which have kept it afloat. Heavily-indebted EU countries would have defaulted long ago under normal circumstances but they have avoided a major crash thanks to generalised sharp increases in taxation, generous EU bailout programmes, and firm commitments by the European Central Bank (ECB), which promised to do all it takes to keep interest rates low, writes Professor Enrico Colombatto. National governments have shelved plans to overhaul their welfare-state systems and have preferred to reap the short-run financial benefits of larger revenues - at the cost of stagnation. EU central bankers have accepted that monetary policy should be in accord with goals defined by politicians. These choices have paid off so far and the EU economy has been growing again but the figures do not inspire confidence. Official forecasts for growth in EU gross domestic product (GDP) in 2014 and 2015 are 1.4 per cent and 1.9 per cent compared with 3.0 per cent in 2014 in the United States. The financial situation of Europe’s troubled economies can stabilise only if tax pressure stays more or less constant and debt servicing does not become more onerous. Greece had a 110 billion euros bailout in 2010 and another 100 billion euros in 2012. Its creditors have been forced to accept a trimming of some 100 billion euros. It is interesting that this total - 320 billion euros - was more or less equivalent to the total Greek public debt in 2010. The financial needs of the Greek treasury over the next three years are estimated now at about 36 billion euros, while the existing bailout programmes have resources available for only some 25 billion euros. The 11 billion euros difference between these two figures is the size of the Greek problem in perspective. Is this 11 billion euros figure important? Could it create another Greek crisis and where could such resources come from? With regard to the first question, the Greek public debt currently amounts to some 300 billion euros. This is some 175 per cent of GDP and it is bound to increase, as the budget deficit will be close to three per cent of GDP. Yet, it is also apparent that given the orders of magnitude involved, an increase in the cost of debt-servicing during 2014 hardly makes a great difference to Greece’s overall debt picture. A one per cent increase in servicing is equivalent to some three billion euros. As a three billion euros gap cannot be covered through further tax increases or further spending cuts - both would be politically dangerous - and since resources must come from outside, does it really make a difference whether the gap is 11, 14 or 20 billion euros? We believe it does not, but if it is true that a rise in interest rates does not change the essence of the Greek situation, why does the economic community pay so much attention to interest rates? And why does the European Central Bank continue to remind the financial community that it will inject all the necessary liquidity to keep interest rates under control? The EU authorities have repeatedly claimed in the last couple of months that there would be no more bailouts at taxpayers’ expense, but only bail-ins, with some possible financial support to sweeten the bitter pill. Those bold enough to buy Greek government bonds in 2013 have been rewarded for their audacity: the return has been around 50 per cent. The market has been inclined lately to believe that while EU austerity may kill the growth prospects of troubled governments, both the EU and the ECB are also providing adequate protection to creditors, should matters get worse. If this belief is maintained, Greece may well return to the financial markets and ask for money in the coming months as Ireland did in early January 2014. Demand for the new Irish 10-year bonds reached 14 billion euros and sparked a rise in the price of high-yield bonds across the whole Euro area. Investors may be tired of sitting on their low-yield German government bonds, their equally low-yield AAA corporate bonds or wary of investing in the Stock Exchange, which some experts consider is ripe for a drastic correction. An eight per cent interest-bearing government bond from a closely monitored euro country like Greece - which has cut government spending by 25 per cent over the past four years and posted a healthy primary budget surplus in 2013 - could be tempting. European authorities may hope that by keeping quiet on the need for a future bail-in (a partial default), by not closing the door to further help (a mini bailout), and by making sure that if things get worse liquidity will be injected promptly, the market will actually end up taking care of the job that Germany, the ECB and the European Commission want to avoid most - a new round of the Greek saga. Our conclusion is that 2014 is unlikely to be remembered as the year of rebounds. Greece’s successful slashing of public spending could inspire investors but the keys to a return to healthy growth remain deregulation and lower taxes.

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