There is a double helix of causes of the eurozone debt crisis.
On one chain (Greece and Portugal) it is a problem of a bloated government sector, chronic fiscal profligacy and weak competitiveness. On the other chain (Ireland and Spain), it is a credit-fuelled asset bubble that burst, leaving the banking system in tatters. So the solutions are also different: cleansing the banking sector for Spain and Ireland; downsizing the state sector and increasing productivity for Greece and Portugal.
The eurozone crisis four (Greece, Ireland, Portugal and Spain) have been running budget deficits of between 8% and 12% of GDP, compared with the eurozone average of about 6.5%. Their gross public debt to GDP has reached between 75% and 130% of GDP. Only Spain will be below 100% of GDP in 2011. And gross financing requirements over the next year are around 20% of GDP.
In Greece and Portugal, the crisis was caused by a bloated government sector, whose fiscal arithmetic was deteriorating even during the boom years because of a lack of competitiveness and low productivity in the private sector that inhibited investment and growth.
In the more dynamic export economies of Ireland and Spain, the government sector was in relatively good shape before the crisis. Ireland was running budget surpluses and Spain was broadly in balance. The debt crisis there resulted from private-sector asset bubbles and over-leverage, funded by an over-extended and now unfinanceable banking and credit system.
With two distinct causes of the debt crisis come two different solutions. For Ireland and Spain, the solution is the cleansing and recapitalizing of the banking system. The solution for Greece and Portugal is a reduction in the size of the state, tax reform and supply-side change to engender efficiency in the economy.
Eurozone sovereign debt crisis As a percentage of GDP * GFR = gross ﬁnancing requirement (maturing debt+budget deﬁcit)
Source: OECD, Independent Strategy
Eurozone sovereign debt crisis
As a percentage of GDP
* GFR = gross ﬁnancing requirement (maturing debt+budget deﬁcit)
However, in all cases there must be a programme to cut down the size of the government sector, restore fiscal prudence and stabilize government debt. In Greece and Portugal there has been a long history of fiscal profligacy. In Ireland, the state has assumed the risks of the banks and the cost of doing so has stretched its own finances to the limit. This fate has not yet befallen Spain, but it could this year.
All the stricken peripheral EMU economies need to grow their way out of their debt burdens. This requires productivity enhancement in both public and private sectors. Thus public-sector deleveraging must go hand in hand with private-sector reform.
The Irish case is interesting as it is a dynamic, highly deregulated, liberal and young (the average age of the population is 35, 13 years less than Italys) economy that is export-driven (to the tune of 50% of GDP).
It has already experienced two and a half years of fiscal tightening and plans another similar amount to come over the next four years. It has suffered a deep recession, with gross national income (the best guide to the Irish economy because of its foreign-owned investments) down 20% from its peak in 2007. But recovery is now under way. Irish exports (40% of which are high-value-added services) are up 12% year on year and industrial production is up 6%.
Spain too can make a sharp recovery. Markets are fixed on the likely hit to the banks from further falls in property prices. But even if commercial and residential mortgage default ratios were quadrupled from present levels and the Spanish government was forced to recapitalize its banks, it would still be only one-third of the cost of the Irish bank restructuring as a share of GDP. Thats because Spanish banks are less than half the size relative to the countrys economy of Irish banks.
Even if a country can claim that it has tried to do all the right things (Ireland), financial markets have lost confidence and only results will calm them. That will take time.
What needs to be done? Europes Financial Stability Facility (EFSF) needs to be increased substantially and such countries as Spain and Portugal should enter an EFSF programme backed by the full weight of EMU governments and European Central Bank liquidity. In return, countries in the programme must cleanse their banks of bad debts and meet the fiscal and competitiveness targets set by the EU and the IMF.
This would be the circuit breaker for the immediate crisis and restore confidence in eurozone sovereign debt. The global sovereign debt crisis would then move elsewhere.
David Roche is president of Independent Strategy Ltd, a London-based research firm. www.instrategy.com
Also this issue:
Market leader: Tensions run high over sovereign debt haircuts
Market news: EU bailout bonds set for debut issue
EU sovereign debt: Bondholders should bite restructuring bullet
Sovereign debt: Principles and practice