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Are markets mispricing Netherlands election risk?

Anti-eurozone sentiment is sweeping the austerity-laden Netherlands ahead of the September national polls. The election could fuel yet-more political risks for the eurozone project, adding to the hawkish sentiment surrounding peripheral European sovereign bailouts.

A recession, subdued domestic consumption, and biting austerity measures to meet stringent fiscal targets. This now all too familiar weak economic backdrop has cast a doubt over the outcome of a crucial September general election in the Netherlands, with euro-scepticism taking centre stage.

Weak real estate prices – amid fears over rising property taxes in the coming years – high inflation and low domestic consumption are the principal causes of an expected 0.5% to 1% drop in economic activity this year and a 3.9% budget deficit-to-GDP ratio, according to ING.

With Fitch affirming the sovereign’s triple-A rating in June and a relatively stable banking system, the Netherlands is riding the crisis stronger than many of its peers. However, the recession is taking its toll amid austerity measures and the political axis has moved in favour of the eurozone sceptics, in a shift that is likely to complicate further monetary and banking integration efforts while adding to the hawkish sentiment surrounding peripheral eurozone bailouts, say analysts.

“Because of austerity measures and weak consumer confidence, the Dutch population is not keen on bearing the rescue of poorer nations and the more-populist parties have been quite successful in playing the anti-euro card,” says Peter Vanden Houte, ING’s chief eurozone economist.

The election is pitching the centrist pro-European parties against strongly populist movements such as Geert Wilders’ fervently anti-euro Freedom Party, notorious for its anti-Islamic stance; and the leftist Socialist Party. Opinion polls show no single party, or traditional political alliance, has a commanding majority. The Netherlands has historically been allied to Berlin and its agenda of fiscal conservatism, but anti-eurozone sentiment is at historical highs, representing another “source of increased political risk for the eurozone”, says ING’s Houte.

He says: “As yet, there is no majority vote in favour of leaving the eurozone but the majority are in favour of Greece leaving the monetary union,” while the outcome of any referendum on greater integration “would be a close call”.

 
Netherlands PM Mark Rutte (L) with German
Chancellor Angela Merkel (R)

Fuelling anti-eurozone sentiment, a report by Lombard Street Research, commissioned by Wilders, concluded that eurozone integration had depressed the country’s trend growth rate to 1.25% year on year over the past decade, compared with 3% in the previous 20 years, while eroding Dutch consumer spending power. In addition, it calculated that the cost of a Dutch eurozone exit could amount to €127 billion to €241 billion over the next four years, yielding an eventual saving of up to €232 billion. It concluded: “Given the need for domestic austerity and lower relative wages in Med-Europe, growth can only be enjoyed in the Eurozone as a whole if the surplus countries, notably The Netherlands and Germany, accept the need for consumption growth faster than GDP, probably breaching the Stability and Growth Pact in the process, and higher inflation than the Eurozone average, presumably at least 3-4% – as well as accepting 10-20 years of outright subsidy of Med-Europe. Failing this, Neuros [Northern Europeans] will be condemned to waste their savings on worthless assets, and Med-Europe to depression.”

In the near term, the Dutch banking system “can stomach the real estate downturn” and the economy’s woes represent no “major problem” for the eurozone’s solvency as a whole, says ING’s Houte . However, in the coming months, political risk could trigger a rise in Dutch government bond yields and sovereign credit default spreads amid any political gridlock, following the September election, and/or a delay in fiscal consolidation efforts, say analysts. Under the shadow of this risk, Credit Suisse says: “Should the centre-left gain power they have not agreed to cut the budget deficit by 2013 but would look to hit the 3% target in 2014. Therefore we think the CDS spreads can widen to price in more of this uncertainty.”

Nevertheless, a continuation of the flight-to-quality sell-off in favour of core eurozone credits could offset this selling pressure, says ING. Aside from the impact for investors, the shifting sands in Netherland’s political economy will no doubt hold a wider significance for the eurozone project, throwing into sharp relief the challenges of intra-eurozone adjustment for both the stronger and weaker economies.

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