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News : EU Economy Last Updated: Apr 14, 2011 - 8:34 AM

State of the Union: Can the Eurozone survive its debt crisis?
By Michael Hennigan, Founder and Editor of Finfacts
Apr 13, 2011 - 5:55 AM

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In a special report, State of the union: Can the eurozone survive its debt crisis? the Economist Intelligence Unit (EIU) says the next five years will be unusually challenging for Europe, even in a best case scenario.

The EIU team with Robin Bew, editorial director and chief economist, as lead author, says the global financial crisis is having wide-ranging and long lasting effects. Among the most serious of these is a threat to the existence of the euro, the most ambitious project in the process of European integration.

The economists say their baseline assumption is for agreed reductions in the debt of Greece by 42 percentage points, to 96% of GDP, and of Ireland by 23 percentage points, to 96% of GDP.

The highlights of the report include:

  • Four scenarios outlining how the financial crisis could evolve in the coming years;
  • An extensive analysis of the problems facing individual Eurozone states;
  • Groundbreaking index to measure each euro nation's vulnerability to contagion and debt default:
  • An overview of the economic and political factors that induced this crisis.

Download report after free registration

The economists say the Eurozone’s current quandary can be summarised as follows. Much of its geographical periphery is highly indebted and must "deleverage". Yet, financial markets fear that this may prove extremely difficult within the straitjacket of the euro. One reason is that all the indebted countries lost competitiveness during the good times by allowing wages to grow faster than productivity; none can now restore their external competitiveness by letting their currencies depreciate against their major trading partners. The crisis, however, is not confined to the periphery. The authors say the sovereign debt crisis in the periphery is bound up with a banking crisis across the euro area as a whole. That connection is overt in the periphery, but suppressed in the core. Some German banks are currently among the sickliest in the region. As such, they are poorly placed to withstand any default on peripheral debt (to which they have large exposures).

The report says: "We expect that both government and current-account deficits in the periphery will narrow in 2011-13. GDP growth is forecast to turn positive in Spain from 2011 and to be weakly positive in Greece, Ireland and Portugal by 2013 (although it will be several more years before GDP exceeds pre-crisis levels). As a result of the stagnation of GDP and falling incomes in the interim years, debt ratios for households and sovereigns are likely to worsen in all countries.

Despite the peripheral countries’ plight, fear of encouraging moral hazard will make the creditor countries reluctant to give them any further respite by easing the terms on which the EFSF lends. As these countries struggle to service their debts, the official "no debt restructuring" line currently being peddled by governments in the creditor countries will look increasingly untenable.

Indeed, in the cases of Greece and Ireland, the primary surplus the excess of tax revenue over spending on public welfare and services required to service their rising debts would be too much to afford. Either these countries would be economically crippled by excessive taxes, or public welfare and services would be reduced to levels no longer compatible with maintaining stable and consensual societies. The issue is likely to come to a head when the ESM becomes operational in 2013. Given that neither Greece nor Ireland will be in a position to access financial markets on sustainable terms by then, we expect them to request a continuation of emergency funding from the ESM (European Stability Mechanism -- the permanent bailout fund that will be in operation from mid-2013)."

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© Copyright 2011 by Finfacts.com

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