After withdrawing into the background in late 2012, the Euro-zone sovereign debt crisis resurfaced in the first quarter with the Italian elections and Cyprus’ banking crisis. In late February, Italy’s national elections resulted in a fractured mandate, and Italians voted out the incumbent, the main architect of the country’s austerity and reforms agenda.
In the ensuing political uncertainty, the global financial community worried about the fate of Italy’s reforms program, which is widely believed to have built investor confidence in Italy and helped the country avoid a bailout in 2012. The inconclusive results also raised doubts about the ability of European leaders to stick to their necessary but unpopular austerity and reform programs in the medium term.
The Cypriot banking crisis late in the first quarter increased concerns about the possibility of other smaller troubled European countries like Slovenia requiring bailouts. Also, in the course of rescuing Cyprus, the European Union and International Monetary Fund (IMF) considered the option of taking money from Cyprus’ bank depositors to provide the bailout money. The plan, which was eventually watered down, raised the specter of depositors and lenders losing confidence in struggling banking sectors elsewhere on the continent.
Among economic developments, the Euro-zone remained in a recession, with the currency bloc’s GDP declining more than expected in the first quarter. To boost growth, the European Central Bank recently cut its main interest rate to a record low but the first-quarter GDP contraction strengthened the case for another rate cut soon. Similarly, the Markit Euro-zone Composite Purchasing Managers’ Index (PMI), which tracks activity in the region’s manufacturing and services sectors, remained below 50, indicating contraction, all through the first quarter. Also, the bloc’s unemployment rate remained in an uptrend during the quarter, reaching 12.1 percent in March.
Germany: Economy Stabilizes after Discouraging End to 2012
After shrinking 0.6 percent in the final quarter of 2012, Europe’s biggest economy appears to have started 2013 on a more encouraging note. Activity in Germany’s manufacturing sector — which accounts for roughly 48 percent of the country’s exports and 25 percent of its GDP — improved in January and February but deteriorated slightly in March. Better still, the country’s industrial output stayed in an uptrend in February and March as robust capital goods and energy production offset the weakness in the construction sector amidst an unusually long winter. Germany’s new industrial orders rose in both February and March, surprisingly on the back of a relatively stronger flow of orders from the recession-hit Euro-zone.
The increase in new industrial orders and production of capital goods, like machinery, augurs well for both Germany and the European Union (EU) since this is expected to provide an impetus for private investments. Germany, where exports drive nearly half of the economic activity, remained largely resilient to the Euro-zone debt crisis until recently thanks to healthy domestic consumption and solid demand for German goods from emerging markets like China.
Lately, though, the country has been struggling to cope with diminishing demand for its exports from EU members as German companies, worried about their revenue prospects, have tightened capital investments. Nevertheless, now that the flow of new orders has strengthened, German firms are likely to build capacity and, in the process, give a boost to their raw-material and parts suppliers across Europe.
Among other noteworthy data, a recent report released by Germany’s finance ministry shows that between March 2012 and March 2013, the country’s tax revenues jumped 5.7 percent due to an equivalent rise in income tax revenues. This is another sign that in sharp contrast to other economies, especially in austerity-hit southern Europe, Germany’s labor market continues to be stable. The unemployment rate — 6.9 percent as of April — is at a two-decade low and falling, which is a significant advantage as domestic consumption is expected to keep Germany’s economy propped up if export demand from Euro-zone members falters further .
The U.K.: Averts “Triple-Dip Recession;” Services Sector Continues to Grow
Britain managed some growth during the first quarter and avoided a much-feared “triple-dip recession.” Having contracted 0.3 percent in the final quarter of 2012, the U.K. economy faced the prospect of slipping into its third recession (technically, two consecutive quarters of GDP contraction constitute a recession) in the last five years if it did not grow in the January-March period. Fortunately, despite unusually cold weather early in the year and persistent weakness in the construction sector, GDP expanded 0.3 percent in the first quarter, thanks to strong growth in the services sector and an increase in North Sea oil and gas output.
The fact that Britain has dodged the so-called “triple-dip recession” is economically and politically significant, given the current ‘austerity versus growth’ debate among policymakers in Europe. Spending cuts have helped several European governments snip their debts, but on the flip side, austerity is believed to be stifling growth. So, there is rising clamor for governments to shift focus from austerity to investments that will drive growth.
Britain too has been grappling with this dilemma, having pledged to reduce its public debt from 11 percent of GDP in 2010 to 2 percent by 2015 through massive social-benefit and job cuts as well as tax hikes. In fact, citing the British economy’s weak growth prospects in an austerity-centric environment, two ratings agencies have cut the U.K.’s triple A credit rating in recent months. Further, the IMF has urged the austerity-focused British government to temper its deficit cuts. Against this backdrop, the modest first-quarter GDP growth has given the government political muscle to stay the course in its austerity program.
To add to the British government’s relief, the various economic data released recently indicate further recovery in the U.K. economy. For instance, activity in the crucial services sector, which accounts for two-thirds of the British economy, remained in an uptrend all through the first four months of this year. The housing sector too appears to be improving, with The Guardian quoting real estate agents as saying that home sales rose in all three months of the first quarter.
France: Major Labor Reforms Underway
France has a distinct edge over several of its European peers — exports account for 27 percent of its GDP while the comparable figure is 32 percent for the U.K. and more than 50 percent for Germany and Switzerland. So, France has not been affected by weak demand for exports from the Euro-zone as much as the other large European economies. Moreover, among all the troubled economies of Europe, France borrows money from the international debt markets at the lowest rates, thanks to its high credit rating.
These advantages notwithstanding, France is still a major exporter, and so it needs to remain competitive in the export market. This is at the heart of the country’s key structural problem. Despite recent efforts to make its labor force more flexible, France has not been able to reduce its unit labor costs. Not surprisingly, therefore, French exports are stagnating – they fell in January and February, recording an uptick only in March.
Declining competitiveness in the export sector has had a ripple effect on various areas of the French economy. For instance, Markit’s France Composite PMI, which tracks activity in both the manufacturing and the services sectors, remained below 50, indicating consistent contraction, in all three months of the first quarter. Similarly, with economic activity slowing down, the number of unemployed people in France touched a record high in March, rising 11.5 percent on an annual basis. The budget deficit has also risen, as government revenues have been adversely affected. Various institutions like the Bank of France and the national statistics office INSEE have forecasted 0 percent-0.1 percent growth in French GDP during the first quarter. But commentators have said that with this degree of economic expansion, the French government may miss its budget deficit target for 2013 as the target has been set assuming 0.8 percent GDP growth this year.
On an optimistic note though, the French Parliament has approved a major labor reform package designed to halt rising unemployment and improve the competiveness of French goods in the export market. Among other things, the legislation has made it easier for workers to change jobs and for employers to fire workers.
Italy: Borrowing Costs Stable but Economic Data Deteriorate
February’s national elections failed to produce a clear winner and Italian parties spent nearly two months brokering and bickering in an attempt to break the political deadlock. Eventually, moderate Left politician and three-time minister Enrico Letta was nominated in April to form a new government through a coalition of nearly all major political segments – the Left, Center, and the Right. Although observers feel that all hues of political parties have indeed finally chosen to avoid further political turbulence, many have expressed fear that the new government may not last its entire term.
Not surprisingly, the early weeks of the new government have been marred by differences over tax and immigration policies. But Mr. Letta, in an attempt to stabilize the government and hold sway over his disparate partners, is taking a tough stance. In a ministers’ meet recently, he announced that he was setting some “ground rules” to force ministers to focus on policies for tackling recession and unemployment as well as for tax and electoral reforms. The political storm in Italy may not have passed yet, but for now, the worst appears to be over.
The new government has its task cut out on the economic front too. Italy has the largest public debt (about 130 percent of GDP) in the Euro-zone. So, it has implemented drastic austerity measures – partly to curtail the debt and partly to induce bond buyers to continue purchasing its sovereign bonds. Worse, Italy has the second largest manufacturing sector in Europe after Germany, but due to high labor costs its goods are relatively pricier in the export market. Hobbled by these two factors, Italy is in a deep recession. Its GDP shrank 0.9 percent during the fourth quarter of 2012 and 2.8 percent between 2011 and 2012. The unemployment rate touched a 20-year high of 11.5 percent in February. Italy’s industrial production contracted 5.2 percent in March compared to the year-ago period. On a positive note though, the country’s borrowing costs remain stable. Last year, Italy’s government bond yields, a proxy for its borrowing costs, had sporadically surged to record levels.
Spain: Exports Robust, Banks Stabilize, but Economy Worsens
The January-March period turned out to be a mixed bag for the Euro-zone’s fourth largest economy. The country has been struggling since 2008 when a property market crash wiped out millions of jobs and left the Spanish banking sector with a large volume of bad loans. And, when the government stepped in to rescue the banking sector, it ended up fiscally weak and indebted. Ever since, the property market bust has had a spiraling effect on the Spanish economy. Before the crash, the real estate sector employed a significant part of Spain’s labor force and accounted for an unsustainably large component of the economy.
Not surprisingly, therefore, Spain has been in a double-dip recession since mid-2011 and unemployment has surged unabated. The government’s austerity drive is widely believed to have exacerbated the economy’s problems. So, it came as no surprise that following a 0.8 percent contraction in the last three months of 2012, the country’s GDP declined 0.5 percent in the first quarter, for the seventh quarterly contraction in a row. The unemployment rate increased 1.1 percent in the first quarter compared to the previous quarter, touching a record 27.2 percent, which translates to more than 6 million jobless people. Similarly, retail sales considering seasonal variations plunged 8.9 percent in March.
However, not everything is gloomy about the Spanish economy. For instance, it appears that with wages falling steadily, Spain has been able to improve its export competitiveness. Despite the global slowdown, Spanish exports grew 4 percent between January and March and during the quarter, the country achieved its first monthly trade surplus since records began. What’s more, the banking sector has been showing signs of a recovery.
Spanish banks, which were propped up last year with aid from the European Central Bank (ECB), consistently reduced the volume of their ECB borrowings all through the quarter. Bank deposits have also improved, indicating that fears of a meltdown in the sector have reduced. Further, Spanish government bond yields, a proxy for the Spanish government’s borrowing costs, have stabilized since mid-2012 when they appeared to be climbing to unsustainable levels.
Greece: Austerity and reforms on Track; Bailout Tranches Sanctioned
According to Greece’s finance minister Yannis Stournaras, the crisis-ravaged country has completed two-thirds of the reforms necessary to rectify its budget-deficit problems. Mr. Stournaras has also projected that by the end of 2013, the Greek government may achieve a primary budget surplus or a surplus before considering debt payments. If the projection comes true, it will be Greece’s first primary budget surplus since the start of the crisis. More importantly, Greece can begin borrowing again from international debt markets by May 2014.
The Greek government is currently managing its finances through the country’s most recent $226.8-billion bailout from the European Commission, ECB, and the IMF. Recently, Greece’s Parliament approved the latest set of austerity measures demanded by the troika of lenders for the release of the next two tranches of the bailout. All installments of the bailout package will come to an end next May, by which time Greece must secure the trust of private investors who can buy its sovereign bonds.
There are other indications too that the worst is likely over for Greece. For instance, the finance minister has confirmed that the country’s industrial production is stabilizing. Bank recapitalization is on track and bank deposits have improved since June 2012, when fears that Greece would exit the euro peaked. Last year, as a precondition for receiving further aid, Greece was forced to negotiate with its sovereign bond holders, including Greek banks, and have its debt restructured. This led to a fall in the value of the bonds, the key assets of most Greek banks, making bank recapitalization necessary.
The positive developments notwithstanding, Greece’s economic situation remains precarious. Its unemployment rate has touched 27.2 percent, Europe’s highest level, and unemployment among youth is 60 percent. Consumer spending has been hit hard by a drastic fall in incomes following a 22 percent cut in minimum wages and tax hikes. And, although lower labor costs have increased productivity and have made Greek goods more competitive in the export market, the outlook for exports has not improved owing to the recession in the Euro-zone.
Other Economies
Sweden remains one of Europe’s most fiscally strong nations. Not being a part of the common currency bloc, it has the flexibility to devalue its currency in order to keep the cost of its exports competitive. But, Sweden, where exports account for 50 percent of GDP, is experiencing slow growth primarily due to lackluster demand for Swedish goods from the Euro-zone, a region that buys a third of the country’s exports. The slowdown is reflected in Sweden’s unemployment rate, which jumped from 8.5 percent in February to 8.8 percent in March, a level considered historically high for Sweden.
FORWARD LOOKING STATEMENTS
Certain statements made in this article may be forward looking. Actual future results or occurrences may differ significantly from those anticipated in any forward looking statements due to numerous factors. Thomas White International, Ltd. undertakes no responsibility to update publicly or revise any forward looking statements.
© Thomas White International
