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The eurozone debt crisis continues to cast a shadow over markets entering 2012, though there is no immediate risk of a eurozone breakup, said Societe Generale at a media briefing this week. The euro will survive in the end, but the process will be long, painful and muddled, the bank added.
Most concerns centre on Italy, given that it has the second-biggest share, or 23%, of the total eurozone government debt and may not be able to finance itself. Italy's average nominal gross domestic product (GDP) growth from 2011 to 2015 is expected to be below 4%, which is lower than the current Italian 10-year bond yield of 7%. Fitch also warned this month that Italy has a “significant chance” to be downgraded.
However, Michala Marcussen, global head of economics at Societe Generale, said that the situation in Italy is manageable. “You have a snowball on your debt, but for now it is a slow snowball,” said Marcussen, “it is not good, but it is not an explosive situation.”
“Although those facilities [in ESFS and IMF] may not be large enough to cover several years of funding, they are certainly large enough to be able to address any immediate concern,” she explained. “There is no risk that we are going to wake up tomorrow and suddenly find that banks could not get any funding, because they can always get some from the ECB.”
To strengthen policy coordination, EU leaders have reached agreements in December last year on the new fiscal compact, the core of which are new limits on structural deficits of 0.5% of GDP and annual deficits of 3%, as well as a ban on debt levels of more than 60%.
However, nothing comes without costs. Societe Generale estimates that between 2% to 4% of GDP will be sacrificed to keep the structural deficit under 0.5%, as opposed to 1% to 3% for the 60% GDP debt rule.
“Meeting those criteria will be difficult for Europe,” Marcussen stressed. “We have not been very good at running a structural deficit of under 0.5% of GDP.”
According to Societe Generale, the euro area has been running with an average structural deficit of 2.7% since 1997, with a range of between 1.2% and 5% — at least more than twice the new rule.
Some analysts argue that ECB could start a quantitative easing (QE) programme without significant impact on inflation, or massively purchase government bonds, but Marcussen sees Fed-style QE is unlikely while more balance sheet expansion is possible.
Legally, Article 123 of the EU Treaty regulates that the ECB is not allowed to fund governments. Politically, Germany is firmly against debt monetisation, while member states may be reluctant to take credit risks on the ECB balance sheet. “Every time the ECB buys a bond, it potentially lowers the credit quality of the remaining bonds,” Marcussen said.
However, the ECB has in fact been aggressively buying government bonds and expanded the balance sheet by more than $400 billion since last summer, during which the Fed has kept its balance sheet constant.
Marcussen also warned that the costs of a eurozone breakup would be enormous. The eurozone would see a complete collapse and a long-term depression if Germany left. “It will be a much more costly scenario for the country [Germany] itself, here we estimate it at 5% to 7% of GDP in the first year after the shock, and that is just the first year,” she said. “It would cost Greece 25% to 50% of GDP in the first year after the shock.”
“There is no quick breakup, but there is not quick resolution,” Marcussen added.
