As we noticed during most of the crisis, when a country shows a constantly increasing current account deficit for several years, in other words spending more abroad than it is taking in, international (and domestic) investors tend to withdraw all their investments, placing the country into a difficult situation.
In addition, we also know that if a current account deficit is financed through borrowing, the country’s economy starts to be considered as unsustainable. This theory is especially applied for EM economies with low foreign exchange reserves. As soon as they start to show a so-called ‘twin deficit’ for a few consecutive years, the situation quickly becomes a nightmare for the central bank to counter the market’s attacks (Argentina, Turkey…).
Therefore, today we chose the chart below that shows the current account (as a percentage of GDP) of the peripheral countries known as GIIPS (Greece, Ireland, Italy, Portugal and Spain). As you can see it, the current accounts of all these five countries are back into surpluses [slightly] after several difficult years. Even Greece (or Portugal), that showed a CA deficit pf -14.9% (resp. -12.6%) are back in the green zone with a CA surplus of 0.7% (resp. 0.5%) in 2014.
(Source: Trading Economics)
However, despite that ‘good news’, the problem is still there… Most of the readjustment of these countries was done through internal devaluation, which obviously ‘killed’ internal demand. Let’s see a second chart that tells you that the ‘fight’ of these countries isn’t over yet if they don’t want to experience a new market attack as they did back in 2010/2011 (and 2012 a bit).
A good point is that peripheral-core yield spreads, a good risk-indicator for the euro-zone, have gradually narrowed since Draghi’s famous ‘Whatever it takes’ back in July 2012 (27th). For instance, the 10-year Germany-Spain Bond spread decreased from 6.35% to 1.33%. The only perturbation we saw lately was in Greece with the 10-year yield that surged to [almost] 9% as the market was concerned about Athens’s plan to exit its bailout ahead of schedule.
However, the chart below shows you the difficulties those countries are facing at the moment. Low consumption due to high unemployment, low real wages and therefore a lack of aggregate demand (thanks to internal wages) has ‘forced’ those countries to run longer [and larger] than expected budget deficits. True, we are far from the 2010/2011 levels (-15.7% for Greece in 2010 or -32.4% for Ireland in 2011) but most of these countries (except Italy) are still above the 3-percent ‘fiscal discipline’ set by the Stability and Growth Pact. Therefore, the ‘large’ budget deficits keep inflating their debt, which are considered to be unsustainable for some economists.
(Source: Trading Economics)
Speaking of debt, here is a chart below that shows the evolution of the GIIPS countries’ debt (as a percentage of GDP) since 2005. As you can see it, we are far from the SGP 60-percent fiscal discipline (green line) for all of them. For your information, the 15% decrease you see in Greece (dark blue) between 2012 and 2013 was due to the Greek debt ‘haircut’ back in March 2012. Briefly, holders of a total value of EUR206bn of Greek bonds were requested to participate on a ‘haircut’ of 53.5% of the nominal value of their titles. In exchange, they were offered a swap of Greek bonds to new bonds issued by Greece (with face value of 31.5% if the face amount of the exchanged bonds) in addition to EFSF notes (tenor 2 years or less) having a face value equal to 15% of the face amount of their exchanged bonds.
(Source: Trading Economics)
Historically, we know that there are several ways to reduce a country’s debt:
– Growth (obviously investors’ preferred way)
– Inflating it
– Default on it (or partial default, aka swap it)
As we said it before, H2 GDP looks ‘ugly’ in the Euro Zone with politicians now busy throwing sanctions to each other (vs. Russia) due to the Ukrainian conflict. Bulge Bracket banks are already forecasting a triple-dip recession in the 18-nation economy. Therefore, the first option is not conceivable for the moment. The only options left are the last two ones. And even though some political parties are opting for the third one, we think the only remaining [and reasonable] option is the second one with a gradual process. This is the problem there, EZ policymakers are looking for higher inflation rates in the Euro Zone as they know they can’t deal with deflation in a ballooning debt environment. The last chart we added represents the annual inflation of the GIIPS countries. We saw last week that EZ flash annual inflation came in [as expected] at 0.4% in October, still far away from ECB’s 2-percent target. As you can see it below, some of the GIIPS countries are already in deflation (Greece in blue since March 2013, Portugal in red or Spain in purple).
With the announcement of several easing measures from the ECB over the past few months (T-LTROs, covered bonds, ABS or corporate bonds), we will see how far the central bank will go to achieve its homework (see article ECB dilemma: Whatever it can…).
(Source: Reuters)
