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Bracing for Europe’s Coronavirus Contractionand Debt Crisis

Economics / Pandemic Apr 04, 2020 - 09:01 AM GMT

By: Dan_Steinbock

Economics

Since inadequate preparedness prevailed in Europe until recently, the consequent pandemic will cast a prolonged, dark shadow over the regionwide economy – starting with the contraction, followed by the debt crisis.

Around the world, the early economic defense against the economic impact of the novel coronavirus has been by the major central banks to cut down the rates, inject liquidity and re-start major asset purchases.


But as the post-2008 decade has shown, monetary responses cannot resolve fiscal challenges.

Bracing for the plunge     

The early damage has focused on a set of key sectors, such as healthcare, transportation, retail, tourism, among others. So easy money will be coupled with targeted fiscal stimuli in affected economies. Yet, current measures to restrict the infection and economic damage will contribute to further debt erosion in major advanced and emerging economies.

Recently, the White House signed the $2 trillion coronavirus bill, the largest ever U.S. stimulus. It may not ensure adequate support for more than 4-6 months. To overcome the crisis, an extended period of 6-18 months may loom ahead when some kind of fiscal accommodation will be needed.

In the US, sovereign debt has increased record fast in the Trump era and now exceeds $23.5 trillion (107% of GDP); that is, before the virus stimulus bill or bills will cause it to soar. And so, we are back in the post-2008 territory that was never supposed to recur. But now, after a decade of ultra-low rates, rounds of quantitative easing and liquidity injections, the situation is much worse.

In the Eurozone, recessionary pressures come in a particularly bad time. Before the virus, the annual economic growth was about 1.0% in the fourth quarter of 2019, signaling the weakest expansion in seven years. However, the first quarter could contract to -3.0%, while the second could be worse than in 2008-9.

In both the United States and the Eurozone/UK, the first quarter damage will only be the prelude to the second quarter carnage. And if the virus is not managed appropriately, the consequent hit will cast a shadow over the hoped-for rebound in the second half of 2020 as well, possibly into 2021.

In Europe, the Maastricht Treaty deems that member states should not have excessive government debt (60%+ of GDP). Today, no major European economy fulfills that criteria. To overcome their short-term challenges, countries will take more debt, which will further erode their debt-to-GDP ratios.

Certainly, central banks in Europe and the UK will follow US footprints into more monetary and fiscal accommodation. But that may fail to quell virus fears, if infection rates continue to soar. As virus mobilization intensifies in European economies, so will new debt-taking.

Even before the virus crisis, Italy’s level of sovereign debt soared from 110% as share of the GDP to the alarming 135% in the course of the 2010s. It will increase a lot faster now. In Spain, the debt crisis of the past decade pushed the ratio from just 60% to a peak of 100% of GDP in 2014. In the past half a decade, it has decreased but that progress will now be reversed.

In France, the ratio climbed from 85% to close to 100% in 2016 but has stayed at that level since then. Those days are now over as the ratio will start climbing. In the UK, sovereign debt was close to 60% in 2010, but soared to close to 85% in 2017, thanks to the impending Brexit. Now the UK will have to face the costs of the Brexit and the virus crisis.

Germany is the only major European economy in which sovereign debt as share of the GDP actually declined in the past decade from 80% to close to 60%. In the past two years, Berlin has been able to offset the US tariff war losses, but now it will have to cope with worse challenges. And when German economy contracts, the rest of Europe will plunge.

The way out                    

In advanced economies – and particularly in the heavily-indebted European countries, which are already struggling to absorb the costs of the 2008 great recession, the 2010 EU debt crisis, the UK Brexit, and the US tariff wars - the coronavirus contraction has potential to wipe out a decade of recovery. But that's just a prelude.

Furthermore, if containment measures fail, or subsequent mitigation proves inadequate, or new virus clusters emerge after containment and mitigation, markets will remain volatile and economies will suffer further damage, particularly if multiple waves of secondary infections recur after current restrictive measures.

What is desperately needed is multipolar cooperation among major economies and across political differences. In this quest, China, where containment measures have been successful, can show the way, along with major advanced and emerging powers.

President Xi Jinping’s call on Trump to improve US-China relations amid Covid-19 crisis and cooperate against the virus is a good start.

But isn't it time for Europe to join the bandwagon?

Dr. Dan Steinbock is the founder of Difference Group and has served at the India, China and America Institute (US), Shanghai Institute for International Studies (China) and the EU Center (Singapore). For more, see http://www.differencegroup.net/  

© 2020 Copyright Dan Steinbock - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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