Uncertainty has returned to Europe in the shape of a new President in France and a highly fragmented poll result in Greece, leading to the high likelihood of a second election there. While the results themselves were not that much of a surprise, the uncertainty is around what it all means.
That uncertainty is greatest in Greece where markets are most concerned about the potential for Greece to fail to meet its obligations under the terms of the second bailout, triggering a cessation of funding from the EU and IMF, followed by default and likely exit from the Euro.
There’s still a lot of water to flow under the bridge before we get to that point. The first step will be the formation of a new government which will most likely require a second election, the timing of which appears likely to be mid-June. In the meantime the political rhetoric will escalate as each of the parties vie for a greater share of the vote in that next poll. However, the process of forming a coalition Government will most likely result in a moderation of extreme views. Once a Government is formed there will then be a decision to be made by the signatories to the second Memorandum of Understanding, the IMF and EU, as to whether they are willing to renegotiate the terms of the second bailout. Ultimately the new Greek Government will have a pragmatic decision to make about the relative costs (and pain) of staying in the Euro or departing.
The odds of Greece exiting the Euro have risen. It’s for this eventuality we have been pleased to see work continuing around building the Europe firewall and the implementation of the two ECB tranches of Long-Term Refinancing Operations. Should a Greek Euro exit eventuate it will be messy, but we don’t think it would have the same negative consequences it would have had last year.
In France, President-Elect Francoise Hollande is to be applauded for wanting a better balance between fiscal consolidation (read: austerity) and economic growth. Unfortunately he is three years too late.
When the European fiscal crisis was in its infancy, there was a window of opportunity to solve the problem of unsustainable fiscal policy by taking a long-term approach. That would have required Government’s to articulate credible long-term plans for dealing with the weighty issues of rising fiscal costs such as healthcare, pensions and broader entitlement policies. That proved to be too difficult.
Such an approach would have afforded a better balance between long-term fiscal consolidation plans and the structural reforms necessary to build higher sustainable economic growth. That did not occur and the opportunity to strike such a balance was lost. That’s unfortunate. We have said previously that we are not believers in the concept of “expansionary austerity”. The best solution to high debt is to pay it back. That requires stronger economic growth.
Instead various governments have at various times been subject to market scrutiny of their finances. Many have been found wanting and have been forced into the position of taking harsh near-term measures. Those same measures that politicians couldn’t deal with in 2010 are now being front-loaded. Politicians are now feeling the wrath of a vengeful public. Take note America.
One recent positive development was the recognition of the need for a “fiscal compact”. It is this compact that Mr Hollande wants to re-negotiate. That appears unlikely if recent comments from Chancellor Merkel are anything to go by. It is more likely that we see the development of a separate “growth pact” to run alongside it. Mr Hollande’s call is made doubly difficult by the fact that his pro-growth policy ideas are not shared with most of the rest of Europe, most notably Germany.
It’s essential and inevitable that Europe policy-making strikes a better balance between growth and austerity. Unfortunately that reality may be some time away. The other important factor here is markets. Any softening of commitment to fiscal consolidation will be dealt to harshly, at least until governments have made greater progress towards reduced budget deficits and stability in debt ratios. Unfortunate but true.