The year has been bad, of course, and the crisis has taken a major toll. Back in September 2011, the International Monetary Fund (IMF) forecast that output in the Eurozone would expand by 1.1 per cent in 2012. The figure was revised down to a 0.4 per cent contraction in October. Unsurprisingly, the damage has been greatest in Greece. In October, the IMF predicted that the country’s debt-to-GDP ratio would rise to 152.8 per cent by 2017, from 144.6 per cent in 2010 – even after it pushed through the largest restructuring of sovereign debt in history.
And Greece wasn’t alone. In southern Europe, investors dumped sovereign bonds, as they worried more about the return of capital than the return on capital. The spread between the five-year yield on the bonds of Spain and Germany hit 7.28 percentage points in late July. The respective figure for Italy was 6.03 points.
But a strong response was quickly set in motion. European Central Bank (ECB) president Mario Draghi tried to calm investors in late July, promising to “do whatever it takes” to save the euro. And in the autumn, the Bank’s governing council finalised details of its programme to purchase government bonds.
The promise to be a buyer of last resort for Eurozone government debt – as long as the countries in question agreed to external supervision – calmed investors. Draghi stemmed bank runs in several peripheral countries, and the risk of the euro being torn apart overnight by intense capital flight faded. As 2012 comes to a close, the Eurozone has managed to retain its 17 members, and the value of the euro against the dollar is close to unchanged.
But broader macroeconomic adjustments have taken place in the background, and the needs of peripheral countries for external financing have drastically declined. Ireland has been the greatest success story. The country registered a current account surplus of 3.4 per cent of GDP in the second quarter of this year. This compares with a deficit of 6.7 per cent of GDP in the third quarter of 2008.
Spain’s current account deficit also narrowed to 2.2 per cent of GDP by the end of the third quarter of 2012, down from 10.6 per cent in the second quarter of 2008. And Portugal’s declined to 2.4 per cent of GDP from 12.6 per cent at the end of 2008. Similar trends were also reported in Greece and Italy.
But now weak growth stands as the biggest threat to the future of the Eurozone. The staff economists of the Eurosystem – comprised of the ECB and the national central banks of Eurozone countries – lowered the midpoints of their GDP forecasts for 2012 and 2013 to contractions of 0.5 per cent and 0.3 per cent respectively.
Even further forward, sluggish European growth will continue into 2014, with growth forecast at a midpoint of 1.2 per cent. Inflation, too, is expected to fall below the ECB’s implicit target. The estimate for 2013 stands at 1.6 per cent for the year, compared to a previous forecast of 1.9 per cent. The equivalent figure for 2014 is 1.2 per cent.
Subdued economic growth will likely leave high Eurozone unemployment rates in an even worse shape. Unemployment now stands at a whopping 26.2 per cent in Spain; 26 per cent in Greece; 16.3 per cent in Portugal; 14.7 per cent in Ireland; and 11.1 per cent in Italy. Low growth and inflation will also leave high levels of government debt vulnerable to shocks, and open to questions of sustainability.
This sorry economic situation is likely to fuel protests across the affected countries, as the unemployed clamour to return to work. Social unrest may reinforce concerns about insolvency. Some electorates are increasingly opposed to the spending cuts required to put their governments’ budgets back into the black.
In 2013, these medium to long-term issues will return to the minds of investors. Even once a sustainable solution is found for Greece, and even after next year’s elections in Germany, the Eurozone’s troubles will be far from over.
David Powell is a senior economist at Bloomberg.