Monday, 30 September 2013

The state of Europe after the Eurozone crisis - a round up of developments

The longest recession in 40 years in Europe appears to have stabilised, but the search for recovery continues. Greece is taking delivery of a third bailout from the Eurozone, albeit tiny in comparison to previous loans. However, exports, consumer spending and corporate investment are still low, hinting that a recovery is still some way off. 

In the banking sector, Basel III minimum leverage ratios are being welcomed, having been recognised as a buffer against future crises. In the US, for example, minimum leverage requirements well in excess of 3% have been proposed, hinting that the Basel requirements are still seen as inadequate. It does also hint that the implementation of a globally comparable leverage ratio - as set out in Basel III - is unlikely to be met with uniform regulations around the world. 

In the EU, an agreement reached between the Member States on June 27th 2013 on a proposed directive states that in future financial crises, bank and financial institution bail-ins will be the default position, preserving depositors' money and sparing the taxpayer. Bail-outs are not ruled out, however, as the agreement gives national governments substantial flexibility to determine how best to resolve a situation. As such, governments can still determine that a taxpayer-funded bail-out is the best solution, and considering that the agreement on bail-ins is not likely to come in to force until 2018, there is still plenty of time for taxpayers to be left firmly on the hook.  Moreover, S&P considers that EU member governments with sufficient financial capacity will continue to support major creditors of systemically important banks, at least until balance sheets recover, and banks are made more resolvable through structural reforms. 

While mortgage agreements and real estate sales are increasing again in the US, the same is beginning to take place in the UK. US new home sales were up 7.9% in August, and were up 13% on the year. (Source: Census Bureau, from S&P Ratings Direct). Lower interest rates in the UK have been partly responsible for the increase in lending, along with the Bank of England "Funding for Lending" scheme which aims to target lending to the real economy, in particular SMEs. Moreover, the govenrment-backed mortgage scheme, has also aimed to boost lending to those who could otherwise not afford to get on the housing ladder, although this has been met with accusations that it will only fuel, rather than address, the housing bubble.

This all sounds remarkably positive, given the travails of the past few years. However a recent report by S&P on the state of the Eurozone is less optimistic. The report concludes that slowdowns in emerging markets, and an economic rebalancing in China, may "start to reduce the credit support provided by global diversification in recent years". The mantra that a diversified economy will weather economic storms better may prove little use should China - along with other developing economies - slow down their consumption, leaving demand stagnant throughout the global economy.

China's growth has slowed noticeably and perhaps more significantly, expectations for China's growth have also fallen. The consensus is that forecasts have fallen by one percentage point over the last year to 7.5%, however this continues to decline. This compares to a GDP of over 9% in 2010-2011, and although the Chinese leadership seems comfortable with current figures, their focus will be on balancing internal demand and consumption with international trade. 

A Eurozone slump, along with negative US fiscal policy developments, slower growth in China or a disorderly reduction in quantitative easing are currently the top risks for global credit conditions. This has had implications for European sovereign creditworthiness, along with corporate credit ratings above the sovereign. Corporate trends in Europe are still mainly negative. Fifty-six percent of S&P rating actions in the second quarter of 2013 were ratings downgrades, while over two-thirds of industry sectors carry "stable-to-negative" or "negative" outlooks. Moreover, S&P expects the Eurozone to remain in recession for the rest of 2013 and has downgraded its real GDP forecast from minus 0.5% to minus 0.8% for this quarter. The ratings agency expects a weak recovery in 2014 with a GDP of 0.8%, but expects that potential growth will remain impaired long in to the future. Furthermore, according to S&P, there is still a one in three possibility that the Eurozone could experience a sharper and deeper recession in the remainder of 2013 that could last into 2014, seeing the recovery pushed back even further into the future. Owing to the structural nature and depth of the Eurozone crisis, the agency estimates that it is unlikely for a recovery to occur earlier, or for GDP figures to improve substantially in the short to mid term. 

recent report by Moody's affirms the provisional AA1 rating of the European Financial Stability Fund (EFSF) based on the contractual elements, including the "irrevocable and unconditional" guarantees by the Eurozone member states, as well as their creditworthiness and commitments to the EFSF. The strong political commitment of Eurozone member states to the Fund is also important, as Moody's assesses that any default would entail "significant pecuniary and political costs" for Europe. However, the rating is subject to a negative outlook, reflecting the negative outlooks on euro area sovereigns that are guarantors to the Fund. The three largest shareholders in the fund, Germany, the Netherlands and France, all have negative outlooks, with Finland being the only eurozone country with a stable outlook currently.