Europe Drags its Feet
The near-term horizon for Europe looks cloudy.
Economic growth has slowed to a crawl across the EU and started falling in the Eurozone in the third quarter. Some countries have been mired in a recession for over a year, including Spain, Italy, and Portugal. Even central Europe has not been spared: GDP fell for four consecutive quarters in the Czech Republic and for three in Hungary. With German domestic demand softening as well, it is a matter of time before the healthy parts of the continent – Poland and the Baltics spring to mind – catch the fever.
On the political front the news are not good, either. In the Greek bailout program, the EU and the IMF increasing play by different books. The IMF’s says that it cannot fund countries with unsustainable debt. That of the EU Commission and the European Central Bank eyes a quick disbursement of suspended tranches to Greece in order to avoid upsetting markets and shifting attention to other weak economic links, such as Spain. While a bridging solution may be found, the debt overhang will not disappear. This means that some form of Greek write-off looks inevitable, spelling renewed political tensions in creditor countries.
Finally, the high hopes of bringing the European Stability Mechanism (ESM) to the beleaguered banks’ rescue are sinking fast. For the ESM – a firewall bailout fund – to lend to banks, a unified supervisory and resolution mechanisms for financial institutions must be in place at a pan-European level. Yet chances of these two arrangements falling into place soon are next to zero. This leaves Spanish banks without a strong potential backstop should some of them buckle under the weight of bad loans that are increasingly marked to market.
Meanwhile, increasing ranks of Europeans are growing disenchanted with the EU, its efforts to cure the crisis, and plans for a closer union. National politics is gradually reclaiming the front seat in the debate about the future of Europe. (For a more detailed discussion of political risk, read my short report here).