Eurozone Forecast - Autumn edition
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25 Octombrie 2011 |
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ERNST & YOUNG S.R.L. |
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Eurozone handicapped by weak growth as its survival is threatened by the sovereign debt crisis
There is little comfort for businesses in the autumn 2011 Ernst & Young Eurozone Forecast. However, some positivity remains around expectations that growth in 2011 ought to remain above the line, despite it only reaching 1.6% rather than the 2.0% indicated in our summer forecast.
Prospects for 2012 are, unfortunately, markedly worse (projected growth of 1.1%), but Ernst & Young is currently sticking to its view of a 2% rise in output for both 2013 and 2014. Nevertheless, growth in developed economies globally is increasingly hard to come by, not least in Europe and the United States. The apparent recovery since the 2008–09 financial crises has been more short-lived than many hoped and expected. Output in the Eurozone is still around 30% short of 2007 levels.
Perplexity and risk aversion will be the most powerful reactions in many boardrooms to the economic outlook. Investment allocations are likely to be very cautious, with many companies looking to internal reorganization and cost cutting along the value chain to sustain and improve profitability. Industries with strong order books, notably aerospace, will continue to surf these troubled waters with relative ease, while the continuous process of upgrading to exploit evolving intellectual property and internet-related technologies should keep companies in the internet space operating at high levels. There is likely to be less enthusiasm among executives in the renewables sector, where governments are cutting back on incentives. Other sectors dependent on public support and procurement will also feel the pinch. Pulp and paper companies may struggle against a falling demand for their products across a broad front.
Companies will also have to grapple with the impacts of political change and uncertainty, such as next year's presidential elections in France, the November election in Spain, as well as the turmoil and domestic critism in Italy and Germany.
Falling interest rates as demand weakens
Our report foresees a benign interest rate environment for the next 12 months, with rates on hold well into 2012. With inflation forecast to fall below the European Central Bank’s 2% target in 2012, the ECB is expected to reverse the move to higher rates it led in April and July. In early September, Jean-Claude Trichet, the ECB Chairman, confirmed a probable change of direction.
These, however, seem to be the only upsides. Households’ disposable incomes are expected to fall this year and to level out in 2012, while consumer demand is expected to be static and unemployment to stay high at around 10%. Overall domestic demand will rise by less than 1% in 2011 and 2012 while growth in business investment will be limited to 2%. The OECD forecasts of early autumn were very much in line with our report.
The Ernst & Young analysis sides with those who believe that, overall, the Eurozone countries' commitment to austerity policies is too severe, and that those countries with more margin of maneuver on budget deficits and national debt (principally the core Eurozone) should put more emphasis on borrowing and spending to create positive spillover benefits across the single currency area.
The evident flattening of German growth in the second quarter of this year is substantially dampening expectations. The US, where growth is also weakening, and the emerging economies, where it remains strong, are, with European Union (EU) markets, important sources of demand for German exports. Exports are expected to contribute three percentage points to Eurozone GDP. Any slackening of export performance will have spillover effects for the Eurozone.
Moreover, the pattern of growth is very uneven because of major divergences in the Eurozone economy. The forecasts for the core Eurozone (Austria, Belgium, France, Finland, Germany, Netherlands and Slovakia) point to growth rates of around 2% a year until 2015, although Germany will fall from 3% to 1.4% next year. But annual GDP growth in the peripheral countries is unlikely to be above 1.2% in the same period. In 2011 and 2012, output will either fall back (Greece -5% in 2011 and -1% in 2012; Portugal -2% in both years) or tread water (Ireland -1% this year and +0.9% next year; Spain +0.6% and +0.9%; Italy +0.7% and +0.4%).
Downside risks are formidable
This adds up to a highly challenging outlook for corporates burdened by an enormous weight of uncertainty. Our report is clear that the risks to these forecasts are all on the downside. Instability in the financial markets and serious weaknesses in the Eurozone banking system allied to, and fed by, the sovereign debt crisis, could severely prejudice the outlook and turn modest growth into recession.
As it is, there are real obstacles to recovery in the peripheral economies now being propped up by EU and International Monetary Fund (IMF) rescue programs (Portugal, Ireland and Greece). They cannot pay off their debts and regain access to financial markets without faster growth, based on much sharper competitiveness. The core recipe for them, and for others in the periphery, is fundamental reform of labor market structures, radical cuts in government spending, privatizations and pension reforms.
The most perilous development in the last few months is the shift in focus of investors' concerns towards Spain and Italy. Both countries' debt issues have to deal with unprecedented yield spreads above benchmark 10-year German Bunds. Continued widening of these differentials would eventually shut them out of the markets. Controversially, the ECB has been purchasing both countries' bonds in an effort to prevent yields going sky high.
Italy and Spain need to refinance €1.5 trillion of debt over the next five years. If the markets are closed to them, the European Financial Stability Facility (EFSF) currently sustaining the three bailout programs would require far more resources than the €440 billion the Eurozone partners are currently committed to allocating. Our forecast estimates that something like seven times that amount would be needed.
At the urgent request of the ECB, both Madrid and Rome have been trying to win back the confidence of financial markets through new structural reforms and austerity budgets aiming at sharply curbing deficits by 2013. Spain has adopted a constitutional amendment to entrench budgetary stability, and Italy says it will do the same. Though unlikely to be very effective in practice, embarking on such changes would respond to an appeal from France and Germany.
Risk aversion is prevailing in corporate boardrooms
The growing fragility of the economic context and awareness that governments will not yet embrace radical solutions to the debt crisis, such as issuing jointly guaranteed eurobonds and greatly expanding EFSF funds, is making corporate boardrooms a great deal more cautious. This is affecting risk assessment and a range of decisions including investment allocations. Our forecast expects no more than a mild 1.5%–2% growth in Eurozone investment next year, which will not provide a real springboard for cutting the 10% unemployment rate and reviving consumer confidence. Business investment is not expected to return to pre-crisis levels until 2014.
Looking at a variety of business sectors, our forecast is reasonably cheerful about the outlook for manufacturing and business services, the former because of buoyant emerging markets and the latter because of Europe’s specialization of skills in financial services. Elsewhere, the outlook is grimmer, with consumer-based sectors, such as distribution, hotels and restaurants, held back by falling real wages and disposable incomes. Construction will remain lifeless because of the lack of recovery of the housing sector in many countries.
Yet it appears that companies are sitting on large reserves of cash. If the political, economic and financial outlooks for the next few months were more positive, companies may be more committed to productive investment in the Eurozone. Instead, emerging markets will surely be given more attention. Diversifying investment alone will rarely be an adequate strategy for sustaining profitability, but for some companies, it will be an important bet on the future.
Handing money back to shareholders will be the preferred method of increasing earnings per share for some boardrooms. They will be prepared to live with criticism that they lack strategic vision and should be positioning for the upturn when it arrives. However, if financial turbulence worsens and corporate financing becomes even more difficult, those that have maintained strong cash reserves may enjoy an important advantage. There is a great deal hanging on an early and successful outcome to the sovereign debt crisis.
