The Euro Zone is Getting Fiscally Fit


Swallowing spoonful after wretched spoonful of austerity medicine over the last four years certainly hasn’t made life pleasant for many Europeans. Despite the euro zone’s emergence from a double dip recession in the second quarter of this year, regional unemployment remains stubbornly high at 12 percent, and youth unemployment in many countries is far worse than that. But even austerity’s harshest critics have now begun to admit that forced belt-tightening has done the job it was designed to do—that is, getting the region’s overextended national budgets into shape. According to Credit Suisse’s European Economics team, the euro area’s 2013 public sector deficit should fall below a target rate of 3 percent of GDP for the first time since 2009, when it reached a high of 6.4 percent. That’s the kind of progress that can become addictive to keep track of. Maybe they should make an app for that.


Most countries in the area are on track to meet their budget targets. Germany posted a small surplus for the first time since 2007 last year, for example, and Credit Suisse expects the regional powerhouse will balance its budget again this year. Even Greece is on pace to achieve a primary surplus (a measure that doesn’t count debt payments in the “expenses” column) in 2013. Next year, the country expects that surplus to grow from €340 million to €2.8 billion.


Some countries, mind you, are hitting their targets in large part because the bar was set so low in the first place. Portugal embarked on an ambitious austerity program in 2012 that cut the deficit by 2.5 percent of GDP. As a reward for its efforts, Portugal was allowed by the European Union and International Monetary Fund, architects of its bailout program, to relax its deficit target from 4.5 percent to 5.5 percent this year. It’s on pace to meet that goal and the government plans to cut a further €4.7 billion in spending by 2014. Spain, which saw its budget deficit peak at 11.2 percent in 2009, stands a good chance of hitting its much lower, but still rather generous, 2013 target of 6.5 percent if end-of-year growth picks up as expected. Italy and France could potentially miss their deficit targets, but Credit Suisse economists think that they, too, could surprise market-watchers by achieving their budget objectives if European growth accelerates.


Europe’s healthier budgets are just one element in a broader, albeit tepid, recovery. The second quarter’s 0.2 percent increase in real GDP won’t be enough to bring all of 2013 into positive growth territory – Credit Suisse expects that the euro-zone economy will contract by 0.2 percent overall this year – but the region can expect modest growth of 1.3 percent in 2014. Business confidence is improving, corporate cash flows are strong, and financing rates are low, all of which point to the possibility of increased corporate spending in the coming year. Robust trade has also been driving growth, and will continue to do so. Spain, Portugal and Greece, for example, have seen wages drop so fast that their goods have become much more competitive in the global marketplace. One final change for the better: European consumers are slowly joining businesses in opening up their wallets again. “In all, it looks as if the euro area economy is moving from a vicious spiral of tight and volatile financial conditions, recession and pro-cyclical fiscal consolidation to a slightly virtuous spiral of economic recovery and financial stability,” Credit Suisse economists wrote in a recent note entitled “A Slow But Sure Recovery.”


All of which has translated into a dissipation of what can only be called outright panic. According to Credit Suisse economists, the chance of a full-scale meltdown is now much lower than it was even a year ago. That’s not to say that the region is entirely out of the woods. Greece, for example, will likely need a third bailout of as much as €11 billion over the next two years to continue paying its creditors. European officials will also have to consider further help for Ireland and Portugal, probably in the form of additional lines of credit.


In short, the overall financial health of the region has improved significantly since fiscal corpulence brought on the crisis. Talk of the monetary union’s demise is now limited to members of fringe political parties, and bond investors are no longer rushing for the exits and driving yields in peripheral countries like Spain and Italy through the roof, something that happened as recently as last year. The relative calm of the sovereign bond market is certainly due in part to the European Central Bank’s pledge late last year to buy on the secondary market the sovereign bonds of any country that requested assistance and accepted further austerity measures. But Credit Suisse believes that individual governments deserve some credit, too, for improving their budget discipline. “Despite an increase in global yields driven by the Fed taper talks, yields in the euro area have barely budged in aggregate, thanks to financial stress reduction in the periphery driven by better economic and sufficiently improving fiscal data,” Credit Suisse’s European Economics team wrote in an Aug. 30 note, “Fiscal Checkup.”


The European economies most out of balance in the lead-up to the crisis aren’t quite ready to run a half marathon, and fiscal consolidation will continue throughout the euro zone next year, Credit Suisse analysts say. Most countries have put the running shoes back on, though, and some can even fit into those 2005 jeans again.


Photo of office towers under construction in Milan by Eugenio Marongiu via