Structural reforms are painfully progressing in the Eurozone - Better news come from the EU periphery

The negative impact of a weaker international environment on exports and ever higher unemployment numbers weighing on demand will continue to dampen growth, extending the recession further this year than previously predicted. Despite some positive signs of improvement across the region little or no pick up this year can be expected unless the ECB takes further significant action, according to the summer Ernst & Young Eurozone Forecast (EEF).

The forecast predicts a contraction of 0.6% in 2013, a slightly larger decline than in 2012. A very slow recovery is then expected in 2014 with GDP growing at 0.9% and around 1.5% a year in 2015-17. Unemployment is forecast to hit a peak of 12.7% of the Eurozone workforce in Q1 next year.


The forecast also notes the shift in rhetoric from policy makers from fiscal austerity to fiscal credibility and estimates that halving the austerity measures currently planned would raise eurozone GDP by nearly 1% in 2014, with Greece and Spain benefitting most. EEF also suggests that more could and should be done to encourage reforms for banks to fund their lending to SMEs more cheaply.


Marie Diron, senior economic adviser to the Ernst & Young Eurozone Forecast comments, “In the short-term there appears to be very little that can help to improve growth across the eurozone. The structural reforms that are being implemented particularly across the periphery could take some time to have an impact on GDP. On the positive side the relaxation of fiscal austerity means that measures that would have otherwise been implemented that could have potentially harmed growth have been avoided.


In addition to a weaker global demand, the forecast predicts that unemployment will peak in the first quarter of 2014 at 12.7% up from the figure of 12.5% that EEF forecast last quarter, equivalent to an extra 500,000 unemployed workers and a total of 20.5 million. Youth unemployment across the Eurozone is also particularly high at 24%. In Greece and Spain it has reached alarmingly high levels at 59% and 56% respectively.


Marie comments, “Eurozone unemployment has risen more than we had expected. The rise in unemployment reflects both the ongoing weakness in the external environment and the fact that austerity has been far more damaging to the economy than many early estimates suggested. Longer term high levels of youth and long-term unemployment will result in workers becoming deskilled and detached from the labor market, hindering the eurozone’s medium-term prospects


Romania struggles on short-term, but boosts positive signs on the long-run


Romanian GDP in the first quarter of 2013 was stronger than expected, with the flash estimate showing that output increased by 0.5% on the quarter. The details of the breakdown have yet to be released, but it is likely that the 2% quarterly rise in industrial activity was the main driver of the increase. In view of this better outturn, we have raised our GDP growth forecast for 2013 to 1.8% from just below 1% three months ago.


And the pace of expansion is expected to accelerate to around 2% in 2014 as external conditions, particularly in the Eurozone, begin to improve and inflation eases. Moreover, the domestic economy is also likely to benefit from a loosening of monetary policy, as the central bank is forecast to begin cutting interest rates towards the end of 2013, facilitated by lower inflation and following other central banks in the region.


However in the short term, growth is still expected to be modest, influenced mainly by the following factors:

  • Weak external conditions– demand in the Eurozone, which absorbs a majority of Romanian exports, is expected to remain weak in 2013, so export volume growth is forecast to be just 0.9%. As the Eurozone slowly moves out of recession over the next year, exports are forecast to rise by 3% in 2014.
  • Real wages growth remains modest– real wages fell in Q1, with inflation outpacing the growth in average earnings. Although we expect inflation to ease in the second half of the year, real wages are forecast to grow only modestly. The labour market remains subdued, with the unemployment rate above 5%. Against this background, consumer spending is expected to grow by 1.5%, up from 1.2% last year.
  • Credit conditions remain tight– credit to the private sector in Q1 was no higher than a year earlier. Moreover, bank deleveraging and the impact of a high number of nonperforming loans will continue to hold back credit supply to the economy in the near future. In addition, FDI remains very modest, with inflows now accounting for less than 20% of total investment.


Looking ahead


The pressure on Eurozone finances does have some positive if painful consequences that should be acknowledged. Although the debt crisis and ongoing recession have severely impacted growth across the Eurozone they have acted as a catalyst for structural reforms that otherwise might not have taken place. It may be cold comfort for European citizens half way through a lost decade, but policy-makers are increasingly aware of the need to accompany fiscal consolidation with long-needed structural reforms which are necessary if the Eurozone is to effectively compete on the world stage.


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