Eurozone: Combining crisis and recovery Global Economic Outlook, Q3 2015

Beneath the surface of the intensifying Greek crisis, the recovery in the Eurozone has continued, and there are even signs that it is broadening. European corporates are moderately optimistic about their prospects.

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The second quarter in the Eurozone was dominated by escalating political tensions around the modalities of the Greek bail-out program, discussions about the future of Greece in the Eurozone, and the future of the Eurozone itself. However, beneath the surface of the intensifying Greek crisis, the recovery in the Eurozone has continued, and there are even signs that it is broadening. In the medium term, European corporates are moderately optimistic about their prospects. A possible Greek exit (or “Grexit”) from the Eurozone continues to be a risk for the Eurozone, the possible impact of which will depend to a large degree on investor perceptions.

Available data for the second quarter suggest that the recovery in the Eurozone continues.

The economic situation

Available data for the second quarter suggest that the recovery in the Eurozone continues. It does so in an unspectacular manner, in line with the trend of the last few months. From a positive viewpoint, the recovery has become more solid.

Overall economic sentiment indicators, such as the European Commission’s Economic Sentiment Index, are stable and in positive territory. Other economic climate indicators for the Eurozone even report an eight-year high.1 Also, consumer-related early indicators such as car and retail sales are pointing upward. At the same time, the fears of deflation that dominated the headlines earlier in the year are beginning to disappear as inflation rates have picked up. Core inflation was at a low of -0.6 percent in January but went up to 0.3 percent in May.

Similarly, investments, which have been the sorrow child of the recovery for a long time, show encouraging signs. They have been growing, albeit modestly, for the third quarter in a row. This suggests that businesses are becoming increasingly confident about the recovery. Even if is too early to proclaim a trend reversal for corporate investments, it speaks for a broader-based recovery.

From a country perspective, Spain has been the fastest-growing economy in the Eurozone in the first quarter (behind Cyprus), showing signs of a strong recovery for the rest of the year.

The corporate outlook 

General corporate sentiment in Europe for the next 12 months is characterized by modest optimism (figure 1). According to the Deloitte European CFO Survey, which is conducted among CFOs in 14 European countries, the overall sentiment is positive, even if there are wide country-specific differences.2

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Regarding the euro crisis, European CFOs have a fairly strong consensus on how it can be solved and how the Eurozone should look going forward.

Regarding their own financial prospects, Spanish corporates are currently the most optimistic, which speaks for the strength of the ongoing recovery. On the other end of the spectrum, French, Norwegian, and Swiss CFOs are the most pessimistic. The pessimism of the latter two can be attributed mainly to the fall in oil prices and the strong appreciation of the Swiss franc. German CFOs’ sentiment lies in the middle of a cross-country comparison, but it recovered sharply relative to last autumn, when the Ukraine crisis was at its height.

Regarding the euro crisis, European CFOs have a fairly strong consensus on how it can be solved and how the Eurozone should look going forward (figure 2). They see national structural reforms as by far the most important measure to escape the growth crisis: 93 percent see them as effective or very effective to overcoming the growth crisis. Strengthening pan-European investment spending comes in as the second-most important measure.3

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On the other hand, European CFOs strongly resist radical ways to solve the Euro crisis. Almost no CFO from a Eurozone country considers dissolving the Eurozone as helpful, and only a few prefer reducing the number of Eurozone members. European CFOs from outside the Eurozone (United Kingdom, Switzerland, and Russia) are much more inclined to recommend these measures. The possibility of deeper European integration is welcomed to very different degrees in Eurozone countries. While Italian and Spanish CFOs are strong supporters, German and Dutch CFOs are more hesitant. This implies that there is strong unity among European businesses about the desirability of the common currency but considerably less consensus on how the euro can be made stronger.

The Greek crisis reloaded

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After the second bail-out program for Greece was extended by four months with difficulty in February, the implementation of the attached conditions has turned out to be even more difficult. The extension was conditional on the implementation of reforms in Greece. However, no mutual understanding, let alone a consensus, of reform necessities and priorities between the Greek government and its creditors has emerged. Consequently, the last tranche of the program, with the condition that Greece needs to fulfill its obligations, was not paid until the end of June. The increasing tensions and growing doubts resulted in massive capital flight from Greece, which the banking system could withstand only due to the European Central Bank’s emergency cash program, Emergency Liquidity Assistance.

At the time of writing, it is unclear whether there will be a last-minute agreement between the creditors (Eurogroup, European Central Bank, and International Monetary Fund) and Greece. If there is no agreement, Greece faces the prospect of a sovereign default and of potentially leaving the Eurozone, even if there is no formal provision in the treaties for such an exit.

Whatever the final outcome of the negotiations, the financial-market consequences of a possible Grexit will hinge on two factors. First, if investors are surprised by a Grexit, it could, in principle, lead to substantial unrest in financial markets. However, given the length of the crisis, which is now in its sixth year, it is doubtful that investors would be completely surprised. Second, the consequences would depend on whether investors perceive Greece as a special case or as the start of a broader restructuring of the Eurozone. If the latter perception prevails, contagion is a danger. If investors expect other former crisis countries to be stable and continue their current growth trajectory, consequences would be more limited.

On the other hand, if Greece stays within the Eurozone and receives the last tranche of the second bail-out program, its financing needs will only be covered in the very short term, but not long after. While the servicing costs of Greek debt as a share of GDP are lower than in many other Eurozone countries thanks to exceptionally low interest rates and long maturities, Greece will need access to external finance to guarantee repayment. If capital markets are unwilling to provide financing, a third bail-out package will very likely come up in the political agenda.