© Edward Walk
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Edward Walk
Chief Economist at Metzler
The current situation with the European economy? Well, it seems that the troika of inspectors - the IMF, the EU and the ECB are not satisfied with Greece because it did not fulfill their main requirements - austerity and restructuring of bonds. I think that especially Germany has lost patience and there is a high probability that Greece will not receive further support and they will leave the Euro zone very soon.
What we are seeing is the politicians trying to build a firewall in order to ease the negative implications caused by the potential default of Greece and exit of Greece out of the Euro, although these implications will not be as severe.
The ECB is currently providing liquidity from the banks so that they do not need to access capital markets in case of Greek default and there would be no additional stress in the financial system. It is another element of the firewall that I have mentioned before, as an attempt to avoid the contagion spread from Greece. Firstly, the risk probability of contagion has gone to relatively low and secondly, Ireland and Portugal do not need to come back to the capital markets this year or next year, which means they will surely get the next rescue package.
In my opinion, European politicians have always made it clear that Greece is a special case. They try to communicate the rest of Europe to stay in tact, that is why the most probable scenario for Greece is to abandon the Euro area and reintroduce the drachma.
In November German Chancellor Angela Merkel sounded convincing when she said that the Euro zone will not permit Greece to leave the Euro zone, however now the situation has changed. The current conditions are that the Greek parliament is passing the reforms, but the bureaucrats are continuing to work as they did before. It seems that Greece has absolutely no will to conduct reforms and no ability to implement austerity. It is not moving in the right direction.
If we take Italy, in my view, the Italian Prime Minister Mario Monti was quite successful so far in passing the austerity measures. Still, he is only half way through and the other half of the troubles is winning a battle with the structural reforms which will assist the GDP advancement, which is his goal that has to be achieved in the next months.
I would give Monti a very positive mark, however I consider the part he already has tackled with is an easier part. He will have to put a lot effort to achieve the necessary social reforms in the labour market and in the product market.
At first glance it looks like Greece and Italy have faced similar troubles, however it is not correct to compare these two countries. Italy is a much more advanced country in terms of structures.
In Greece there are no bureaucratic institutions which makes it in this sense very similar to the emerging markets.
Italy is a more developed country with a clear institutional structure. It is executing changes in the Parliament and in the laws. The problem with Italy is that before the 1990s it had a lot of debts, for instance, by the end of the 1980s the debt to GDP ratio was relatively similar to its current level.
More or less in the last 20-30 years, although it was not able to reduce the debt level completely, Italy was keeping the debt level stable with a relatively solid fiscal policy. To some extent Italy's troubles are the legacy of the past, on the other hand it is the economy which is underperforming due to difficulties in the labour market and the product market.
This reminds me of the situation Germany has faced in 2003-2004 when the unemployment rate was 12% and how Germany managed to cure itself by implementing the structural reforms which have resulted in a relatively healthy labour market. As I see it, Italy has to apply the same approach as Germany did.
EUR/USD
What is supporting the Euro is that the European banks are deleveraging, meaning that they are selling assets outside of Europe and are bringing money back. This, undoubtedly, has been causing an upward pressure on the Euro's exchange rate. On the other hand we can observe that the ECB is now providing ample liquidity and interest rates have been cut. This is something that should be supporting the Euro, however, the deleveraging of the banks and the liquidity of the ECB have more or less have cancelled each other out.
The Euro has been relatively stable up till now, but our expectation is that in the next 3-4 months when the deleveraging will have slowed down we should see some more Euro weakness. Good news is that this will be very positive for the export growth, especially for Italy and Spain. For Germany it will be too much as the economy may go through the roof, however for other Euro zone members this could be quite helpful.