Summary:
– 2014 should see a return to growth for advanced economies, although countries experiencing a recovery will need to confirm their recent upturn.
– The implementation of structural reforms between 2008 and 2013 should help to correct certain imbalances in the eurozone, but although the signs are encouraging, the expected effects are slow to materialize.
– Lack of confidence and problems with loan allocation and investment could minimize the impact of reforms on growth and thus threaten the recovery in advanced economies.
The concept of country risk is not exclusively reserved for emerging countries, as recent years have clearly demonstrated in view of the many difficulties encountered by advanced economies. Since 2007, the latter have entered a long downward spiral: financial turmoil, macroeconomic imbalances, zero or negative growth, falling investment, and rising unemployment. In the meantime, adjustments have been made and reforms undertaken. The main message emerging from Coface’s annual country risk conference is that there is hope for a return to growth and stability in advanced economies in 2014, but caution is required as certain risks have not been completely eliminated or ruled out.
Encouraging signs
After six years of crisis, the epicenter of which has shifted within the advanced economies between the United States and Europe, 2014 could therefore be the year that marks a turning point and heralds « the end of the descent into hell, » according to Y. Zlotowski, chief economist at Coface. He has painted a fairly positive (or at least not too negative) picture of the situation in developed countries:
« Corporate America is back » is the slogan that characterizes the recent performance of American companies: low debt, minimized energy constraints thanks to shale gas exploitation (energy prices in the US are nearly one-third of those in the European Union), and an accommodative monetary policy supporting economic activity. The latter will continue until full employment targets are met, but the announced slowdown in the Federal Reserve’s (Fed) support policy could potentially pose a risk if the US economy remains too dependent on the Fed’s continued injection of liquidity.
The eurozone as a whole is expected to record positive growth in 2014, but there are significant disparities between countries. Germany, the symbol of a healthy Europe, with consumption making a significant and positive contribution to GDP growth, should continue to be the driving force behind the eurozone. In France, consumption is also supporting sluggish growth as best it can, demonstrating a form of stability and vulnerability, accentuated by persistent unemployment. Despite a worrying increase in the number of corporate defaults, the costs associated with these bankruptcies remain lower than in Germany, where the number of defaults is lower. In the peripheral countries, public finance and current account imbalances continue to weigh heavily on the economies. However, the reforms undertaken have boosted exports, particularly in Spain and Ireland, thanks to improved price competitiveness, but this remains insufficient to reduce mass unemployment.
In the United Kingdom, despite a public deficit and high public and private debt, a recovery is taking shape. Here too, monetary policy is very accommodative and the Bank of England is helping to maintain activity. However, the British economy relies heavily on financial services and, above all, on the highly volatile construction sector, which is not achieving productivity gains and is prone to speculative bubbles.
Japan is also experiencing a deterioration in its public finances but can count on the effects of Abenomics to ensure positive growth. As in Germany, consumption is contributing significantly to GDP growth, notably with a positive wealth effect thanks to the rise in the Nikkei and a decline in savings. Although businesses are benefiting from the recovery, wages have not yet seen any gains.
Divergence and imbalances…
As J.C. Trichet, former President of the European Central Bank (ECB), pointed out in his introductory speech, the epicenter of the crisis has shifted from the United States to Europe, and more specifically to the eurozone. The latter has gone through several difficult years with the emergence of private and then sovereign risks, generated in part by a significant accumulation of macroeconomic and financial imbalances.
Despite the convergence of European economies during the 1990s to join the eurozone, the end of the 2000s showed that this convergence was far from perfect. The Stability and Growth Pact (SGP) alone could not ensure this, especially since the sanctions provided for in the SGP were not applied when Germany or France failed to comply with it. By focusing on public finances, the Eurozone undoubtedly failed to pay sufficient attention to private debt, credit risk, and current account imbalances.
Private risk ultimately caught up with the eurozone and turned into sovereign risk, leading to a significant deterioration in public finances in some countries, a sharp drop in economic activity, and a dramatic rise in unemployment. Europe emerged from this period highly fragmented and had to set about correcting these imbalances through numerous reforms.
Reforms and adjustments, certainly…
Improving the competitiveness of businesses was quickly announced as the main project and battle cry of the eurozone in order to return to growth. Numerous reforms were then undertaken across Europe to meet this objective. It was mainly in the most fragile countries (Greece, Portugal, Ireland, Spain), with current account deficits, that far-reaching reforms were implemented to strengthen their price competitiveness through lower unit labor costs and labor market reforms. Wage adjustments, reductions in social security contributions, and an increase in the retirement age are all factors that should strengthen the competitiveness of businesses through productivity gains and lower prices.
Since 2008, results have been seen mainly in the so-called peripheral countries, such as Ireland and Spain, and to a lesser extent Greece. The reduction in their trade deficits is not solely attributable to an increase in exports, but also to a decline in imports, due in particular to private and public debt reduction processes. Germany began its adjustment in the 2000s and did not have to pursue further reforms, as its competitiveness (price and non-price) was already strong. However, like other countries with current account surpluses (the Netherlands, Austria, and Finland), it must implement measures to promote domestic demand, particularly to encourage a return to investment. Italy, on the other hand, is experiencing political and economic setbacks and has not yet undertaken sufficient reforms, to the extent that it is gradually being considered a peripheral country. France is not in a situation comparable to that of Italy, but is one of the least responsive countries when it comes to taking significant measures to meet growth and competitiveness objectives.
For P.C. Padoan, Deputy Secretary-General and Chief Economist at the Organization for Economic Cooperation and Development (OECD), structural reforms are more than necessary but unfortunately can take time to produce significant effects. This delay is all the more significant when there is a clear lack of confidence, which is still the case in many countries.
… but also a return of investment
Confidence is a concept closely linked to liquidity. And currently, even if the « descent into hell » is behind us, a robust recovery cannot be assured without a return of confidence. The sub-liquidity crisis in the interbank market (following the subprime crisis), the process of deleveraging undertaken by economic agents after 2008, and the phenomenon of deleveraging in the banking system have had a significant impact on the credit cycle. As a result, the economies of the eurozone have been underfed in terms of liquidity, despite massive injections by the ECB.
This lack of investment is not unique to the so-called peripheral economies but affects the entire eurozone, including countries in good health. If liquidity does not reach businesses in the form of new credit, the efforts made by countries that have implemented structural reforms may be in vain. The risk is that a negative spiral will set in: few loans to businesses, no recovery in investment, low activity, less impact from reforms, increased social risk, market mistrust, crisis of confidence, and scarcity of liquidity. This observation was made by P.C. Padoan and echoed by A. Bentejac, founding president of OMEA TELECOM, who suggests implementing public policies that create incentives for investment. Such incentives could prove effective but insufficient if they are not accompanied by a simultaneous reduction in interest rates for businesses.
The other key problem related to the lack of investment is its allocation. If investment is directed towards sectors producing non-market goods and services, it will not necessarily be effective. Even if these sectors offer the advantage of a better return on investment, they generate virtually no productivity gains and are also highly volatile (such as the construction and real estate sectors). Companies in the market sector suffer from this lack of investment, and it is very difficult for a young, innovative European company to obtain financing from banks without paying high interest rates. J. Santiso, director of Telefonica, provides the following figure: in the last 20 years, one innovative company in Europe has made it into the Top 500, compared to twenty in the United States. The German Mittlestand model, with its highly competitive and attractive small and medium-sized enterprises (SMEs), does not yet seem to have found an echo among its neighbors.
Conclusion
Advanced economies are in the midst of an adjustment phase, which is likely to continue in 2014 despite encouraging signs of recovery. However, if the reforms put in place are slow to produce results, social risks are to be expected, especially in countries where these measures have been most significant and where discontent is already high. The allocation of liquidity could also play an important role in determining the extent of the recovery, as investment needs are pressing. Public debt levels would need to fall rapidly in most advanced economies if they are to avoid seeing their public debt interest charges rise when central banks raise interest rates, which are currently between 0 and 0.25%. However, this risk is not necessarily likely to materialize in 2014, given the continued support of central banks for economic activity.
Victor Lequillerier
References
C. Bouillet (2014), « Eurozone Euro: vers une (re)convergence économique? » , » BSI Economics.
M. Delle Donne (2013), » Ireland emancipates itself under the watchful eye of the Troika , » BSI Economics.
M. Isoré (2013), » Long-term relationships between banks and businesses and credit rationing , » BSI Economics.
V. Lequillerier (2013), » German labor market reform: a truly attractive model for the rest of Europe? , » BSI Economics.
V. Lequillerier (2013), » Corporate deleveraging: what does the future hold? , » BSI Economics.
N. Pietrzyk (2013), » Competitiveness, a concept to be used with caution , » BSI Economics.
T. Renault (2013), » Reform of pension financing in France: the Swedish example , » BSI Economics.
