5 challenges for the eurozone

Christine St Anne  |  22/02/2013Text size  Decrease  Increase  |  

Christine St Anne: Despite some optimism growing in Europe key issues remain. Today I'm joined by Vanguard’s Peter Westaway, to look at five specific challenges now facing Europe. Peter, how is Europe grappling with its peak to reduce its debts?

Peter Westaway: Well, I think the real problem for Europe is that it’s starting from a position where some of its countries have very high debt. They have very high deficits. And even though they are starting to implement physical consolidation programs, it takes a very long time for that to show up in debt ratios falling.

So, for most countries they still haven’t got themselves back into their fiscal surplus, which is one of the conditions that would help debt ratios to come down. And of course, because their growth rates are still so low, in some cases actually negative that means the denominator, effectively the ratio is still going up. So all told, debt ratios probably aren't going to start coming down convincingly until at around 2015 and 2016. But the right policies are being put in place for it to start happening.

St Anne: Do you see any light at the end of the tunnel in terms of growth in Europe?

Westaway: Well, we’ve just seen yet another quarter of negative growth in euro area and the euro area as a whole. And we’re probably not going to see positive growth for the aggregate euro area until probably the middle of this year 2013.

I think we're probably just starting to see these countries bottoming out in terms of recessions. Some of the forward-looking indicators is looking a little bit more promising, and just the very fact that some of the most aggressive physical consolidation is probably already happened.

So, arithmetically that means that growth start to become a bit less negative. Nothing more generally as Germany starts to pick up, as some other parts of the world start to get a bit stronger, that will also help Europe as well. But I mean let’s not hit ourselves. I don’t think we’re going to have anything like strong growth, more than 1.5 per cent for the next couple of years. It’s a long haul, I am afraid.

St Anne: Peter, are you starting to see any countries that are beginning to claw back their competitiveness?

Westaway: There are a few. I mean, a lot of countries lost a lot of competitiveness because they had low interest rates that they never really enjoyed before. They had a credit boom, say countries like Ireland, Spain, Greece, Portugal; all let their inflation rip, wage growth was too high.

Now the recession is really biting in these countries that then obviously act as a dampener on wage growth. So that's helping competitiveness to come back. Probably the country that’s doing best is Ireland where they’ve clawed back healthy, probably more than 50 per cent of their lost ground and that's partly because they are one of the countries that’s just inherently more flexible. They don’t have some of the problems that some of the other countries have on the structural reform side.

St Anne: Structural reform is of course another challenge in the region. Are you seeing any gaps in particular countries?

Westaway: There are a lot of big gaps, and really in some ways those challenges are the most important because until a lot of these periphery countries just start performing like a modern economy should, it is going to be very difficult for these countries to move forward. I mean the main gaps are in areas for example, wage flexibility, the ability of firms to hire and fire workers, restrictive practices in a number of industries, which means that there closed jobs, which makes it difficult for the economies to be dynamic.

And then there are just more generally, infrastructure spending, education spending, sort of being held back for a long time in these countries. And so all of these things together will help some of these periphery countries grow. But these benefits don’t come through quickly, it takes a long time.

St Anne: Peter, finally, are the European banks still vulnerable?

Westaway: Yes, banks are very much in the kind of epicenter of sovereign crisis, and it's in a way, the interrelationship between the banks and the sovereigns that makes it so difficult. You know, countries like Greece bought – the banks in Greece bought sovereign debt that brought them down and then in countries like Spain and Ireland the banks went burst, and the government had to bail them out. So banks and sovereigns are in this deadly embrace.

Gradually, we're seeing recapitalization happening. And that’s helping, but while growth is so low, there are still a lot of very impaired assets on these balance sheets, and the exposure of the banks to sovereign debt and to the bank debt of other countries means that there is an intensification of the sovereign crisis. Banks are very vulnerable and they won’t be able to lend money to firms and households and that could cause the recession to intensify again. Hopefully that won’t happen, but that’s the risk.

St Anne: Peter, thanks so much for your time today.

Westaway: Thank you.

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