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The ECB will not bail out indebted countries indefinitely. A plausible scenario assumes a drop in GDP of up to 10%.
This is not a forecast, but I think it is a plausible scenario. After measures against the economic impact of the coronavirus agreed last week by EU finance ministers, investors will analyze the fine print and conclude that the bailout will have no macroeconomic impact.
This is what Wolfgang Munhau, an analyst at the Financial Times, says in his analysis.
Here’s what it predicts about Europe’s financial future:
Its main elements are a credit line from the European Stability Mechanism, a credit line from the European Investment Bank and reinsurance for national unemployment plans.
The dispute over whether a loan from the ESM rescue fund should be accompanied by additional conditions will be forgotten. Italy doesn’t want one anyway. Prime Minister Giuseppe Conte concluded that his government would not survive the humiliation.
The only program capable of having a real economic impact is the post-crisis recovery fund. But nothing specific was agreed. The idea of ”co-bonds” as a fundraising tool for the fund appears to be losing momentum.
Now I hope that the European Council will negotiate a small recovery fund within the EU budget for 2021-2027, with the usual exaggerated statement of what this amount can do. The main function of this fund will be to seek the attention of inactive European institutions, without a real macroeconomic impact in an economy of 12 billion euros.
So we are left with national fiscal policies and the support of the ECB. My initial assumption is that the economic impact of the crisis will be greater than expected.
German economic institutes have produced a dubiously accurate joint forecast for a 4.2% decrease in national GDP this year, followed by a 5.8% increase in 2021, the perfect recovery of the V-curve. If they are right and this applies to the euro area as a whole, then the problem is solved.
But I think they are wrong. Their forecasts do not take into account the effects of quarantines on the global network, the long-term impact on sectors such as transport and tourism, and the possible second wave of winter infections. My scenario suggests a drop in GDP in the euro area closer to 10 percent this year, with Germany performing slightly better than average and Italy and Spain worse. I also suppose that the German economy will recover moderately in 2021, and the southern part of Europe, not so far away.
The combination of rising debt and falling GDP will raise Italy’s debt-to-GDP ratio from the current 135% to the order of 160 – 180%.
Most ECB board members will always support the euro area economy in times of crisis. But I would not bet that the ECB will bail out indebted countries indefinitely. Its emergency programs will end, and people will begin to remember President Christine Lagarde’s comment last month that the bank’s job is not to close spreads. There are quite a few people on the Governing Council of the ECB who share the same opinion.
At some point, rating agencies and investors will begin to question Italy’s creditworthiness. What happens if the agencies conclude that they cannot pay their debts and successively lower their credit rating?
Imagine this happening in 2021 or 2022, just before the next general election in the country.
Conte and his government are popular now, will he continue to be popular after the depth of the recession becomes apparent? Matteo Salvini, a relatively marginalized figure from last year, could make a political return. And if you finally win the elections in 2022 or 2023, your government may be tempted to go into debt. So what?
Like any scenario, it depends on uncertain events that unfold in a certain sequence. I hate putting numerical values in my forecasts, but I think this scenario is no less likely than the optimistic recovery of the V-economy on which current policy is based.
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