Worst of the eurozone crisis may be over

Signs from financial markets, real economy point to improving prospects

(PARIS) The signs are growing that Europe may have turned a corner in its struggle to restore financial stability.

The evidence comes partly from financial markets, which are calmer, partly from the real economy, which is perkier, and partly from policy, which is responding at last to some investor concerns.

There are still plenty of risks - lack of faith in planned stress tests of European banks, low or no economic growth, more credit rating agency downgrades of sovereign debt, an eventual Greek default or debt restructuring, weaknesses in eurozone governance, and political resistance to painful reforms.

But on balance, things are starting to look up.

'The figures we have are not confirming this pessimism,' European Central Bank president Jean- Claude Trichet said, dismissing analyst predictions of stagnation or even an austerity-induced double- dip recession in the eurozone.

'There is a tendency among some investors and market participants to underestimate Europe's ability to take bold decisions,' Mr Trichet said in an interview with France's Liberation published on the ECB's website on Monday.

'In their defence, I would simply say that the institutional structure of Europe is very different to what they are used to, especially on the other side of the Atlantic.'

Although the Europeans may not have time to arrange the recapitalisation of any banks found vulnerable before the results are published, there is a strong political commitment of governments to do so where necessary, possibly drawing on a newly established eurozone financial backstop, created in May originally to lend to states shut out of credit markets.

The existence of a 440 billion euro (S$766 billion) European Financial Stability Facility (EFSF) guaranteed by eurozone states should reassure investors that any exposed banks won't be left twisting in the wind, even though it would require a unanimous political decision to use it.

So let's examine the case for a turning point.

The euro has recovered from lows of around US$1.19 to touch two- month highs above US$1.27 last Friday, partly due to disappointing US economic data.

Spain and Portugal have been able to sell their debt at auctions, albeit paying higher risk premiums.

The ECB withdrew 199 billion euros in crisis liquidity from the market smoothly at the end of June, and the central bank's emergency purchases of eurozone government bonds have steadily declined. Mr Trichet felt confident enough to highlight that tapering-off last week.

European stock markets have begun to rebound, led by bank shares, on growing expectations that the stress tests will not uncover new horrors.

Governments across Europe are introducing austerity measures to bring down public deficits, and structural reforms designed to address longer-term problems of ageing populations, rigid labour markets and soaring health costs.

Greece, under the whip of a European Union/IMF bailout programme, is pushing through unpopular reforms - cutting pensions, raising the retirement age and reducing layoff payments and notice.

France is raising its retirement age and the contribution years needed for a full pension. Spain is easing hiring and firing laws to try to bring down 20 per cent unemployment.

This will not be smooth or easy, given resistance from labour and interest groups, but the political climate is more permissive for such reforms than at any time in a generation.

At the EU policy level, the Greek bailout and the EFSF are on track and the stress tests are under way.

Governments are broadly agreed on strengthening enforcement of the bloc's battered budget discipline rules. The EFSF, created as a temporary expedient for three years, may be extended and morph into a permanent crisis resolution mechanism.

Longer-term worries, particularly about Greece's ability to pay its debts on time and in full, may continue to dog the eurozone, as well as pessimism about the economic growth prospects of ageing and inflexible west European societies.

Protests against austerity and a shrinking welfare state may grow. Governments may fall over unpopular reforms. But for now, it looks as if the worst of the eurozone crisis may just be over. -- Reuters, Bloomberg

Source: Business Times, 14 Jul 2010