A long and winding road to Europe’s recovery

The seemingly endless deluge of mostly dreary economic figures such as growing unemployment and weak manufacturing output from across Europe reinforced the view that the road to the region’s recovery remains long and winding.

From all indications, Europe is already in recession, economic analysts said.

In the case of the United Kingdom, there’s fear that a double-dip recession could extend as household spending continues to be weak. This recession is happening at a time when the eurozone remains deeply mired in a debt crisis that stemmed from large budget deficits following years of excessive spending.

“What the European Union did in the last two years was to provide the necessary steps to prevent a default. However, the problem continues to evolve as the global economy slows down,” said Jonathan Ravelas, chief market economist at BDO Unibank.

He expects Europe’s debt crisis to hog the headlines for another one to three years—a forecast which, according to him, is even optimistic.

US investment house Merrill Lynch expects the eurozone’s Gross Domestic Product to contract by about 0.7 percent this year.

That’s more pessimistic than the outlook of the European Central Bank, which is looking at the possibility of 0.3 percent growth this year.

For the Philippines, the crisis in Europe could lead to reduced trade, lower remittances and fewer investments. Yet, no one seems petrified.

In fact, stock market participants believe that the market has room to rise further.

Over the short term, the local market should continue attracting funds that seek fatter returns as they flee from beleaguered Europe.

“It will take years for Europe to recover,” said Astro del Castillo, managing director at First Grade Holdings. “The local market will remain sensitive (to developments in Europe) just like the other markets.”

Even so, Del Castillo explains, unless the European debt level and economic situation significantly worsen and drive down global market sentiment to the point of extreme risk aversion, there will be opportunities for the local market to gain, as what happened in the first half of the year.

Economist Victor Abola of the University of Asia and the Pacific cites a number of reasons for the country’s resiliency.

He said the impact of Europe’s recession in the Philippines is small, noting that the country’s exports to the European Union in 2011 accounted for only 12 percent of total exports that year and could even go down to below 10 percent in 2012 from 18 percent in 2000.

“The worst case scenario impact is a complete breakdown of the EU, which would be a major disruption in the world financial system, and this would impact negatively trade flows. However, this has a low probability of occurring,” said Abola.

Problem of deleveraging

In the meantime, the challenges continue.

By Merrill Lynch’s estimate, European banks have EUR2 trillion in assets to shrink, a move necessary to allow them to recapitalize and strengthen their operations.

“We know that quite a few of the larger European entities have very large exposures historically and presence in this region (Asia) generally. And the whole process of deleveraging is a major problem potentially if it continues at a rapid speed,” said Johannes Jooste, European portfolio strategist at Merrill Lynch Global Wealth Management, at a recent media briefing.

And while banks are pulling back lending, demand from corporate borrowings is also shrinking as business slumps.

“Both the supply and demand sides of the credit equation are under pressure. The deleveraging story is happening on financial balance sheets but it’s also happening on corporate industrial balance sheets as well,” Jooste said.

In the euro area, unemployment stood at a record high of 11.1 percent in May, according to the European Union’s statistics office. The job losses were the outcome of declining demand and cost cutting by companies preparing for the possibility that the worst may not be over.

In Germany, the largest growth engine in the 17-nation single-currency bloc, the manufacturing sector showed its fastest rate of decline in three years in June, according to a July report.

The string of discouraging data reversed the optimism generated by agreements reached during June’s EU summit to combat the eurozone debt crisis.

On June 29, European leaders agreed to allow the eurozone’s permanent bailout fund, the EUR500 billion European Stability Mechanism, to directly inject funds to struggling banks to prevent bank failures that could send shockwaves to the region.

A major concern up to now is how fast the debt-to-GDP ratios of European governments could rise as they pay for the bailout of banks.

That concern was crystallized in Ireland where bank failure driven by a property bubble necessitated a bailout. Virtually overnight, its debt-to-GDP ratio became unmanageable as the debts and consolidation that occurred shifted from the failed bank balance sheet into the government’s balance sheet.

All eyes are now on the massive property problem of banks in Spain, the most recent case and closest in nature to Ireland.

In the past two years, the European Central Bank took several steps to resolve Europe’s debt crisis. These were the purchase of over EUR200 billion in government bonds of financially weak countries to lower bond yields and their borrowing cost, the release of a total of about EUR1.02 trillion in three-year low-interest rate loans to banks on two occasions, the cut in banks’ reserve requirement to 1 percent from 2 percent, and the reduction in ECB’s key interest rate by 25 basis points three times since November 2011.

Another move was made on July 5 this year, when it lowered its base rate to a record low of 0.75 percent in a bid to stimulate the economy.

Issue of political will

There are questions, however, whether all of these moves are enough to resolve Europe’s debt woes and put the region back on the growth path.

Economists say Europe’s problem is a very serious one that would involve restructuring of the macroeconomy and institutions.

Europe’s thrust is now anchored on adopting a common fiscal policy and banking supervisory framework that will work for the region.

Bangko Sentral ng Pilipinas Deputy Governor Diwa Guinigundo said in an e-mail that the more pressing issue for Europe is to maintain a united front.

Greece’s exit from the single-currency bloc could upset this intention, he said. Greece has been touted to leave the eurozone as it defaults on its debt and fails to effect austerity measures prescribed in its loan agreement.

Guinigundo also said that the issue of political will is key in the bloc’s plan to unify its fiscal policy and bank supervision.

“Europe will have to demonstrate stronger political conviction in forging a durable solution to their present woes,” he said.

At the same time, any help will be needed at this point as banks deleverage or reduce debts.

“When the banks are deleveraging, and funding exercises are more difficult and costly, the issue is indeed whether their latest funding exercise will suffice. Sovereign debt and bank stresses cannot be addressed as a one-off process,” said Guinigundo.