The debt and deficit challenges that
drove the Eurozone to the brink in 2011 have largely faded from the news since
the restructuring of Greek debt in March 2012. However, we have continued to
monitor debt/GDP levels in the Eurozone, and specifically in the periphery
nations. In August 2012, the European Central Bank’s announced its OMT, or "Outright Monetary Transactions" program, a program that would allow it to purchase
unlimited amounts of member states’ debt in the secondary market under certain
conditions. Since the program was announced, yields on Italian and Spanish debt
have declined precipitously and, it would appear, investors have taken this as
a signal that the danger has all but past. Sadly, but not surprisingly, the
debt of the peripheral nations has largely continued to rise unabated.
Eurostat, the official statistical
agency of the European Union, recently published debt/GDP ratios for members of
the European Union. On a quarter-over-quarter basis, Europe made negligible
progress in taming its burgeoning debt as the ratio for countries sharing the
common currency declined from 95.7% in the second quarter of the year to 95.1%
at the end of the third quarter. However, we must also add that this may indeed
be due to seasonal issues. Eurozone debt/GDP bas declined in the third quarter
in nine of the last 14 years despite the steady upward trajectory of the debt
ratio. Four of the five instances in which the ratio increased in the 3rd
quarter have occurred in the last six years, yet Eurozone debt/GDP increased
24.9 percentage points from the 3rd quarter of 2008 through the 3rd
quarter of 2013. In short, the modest improvement from during the 3rd
quarter may be due to seasonal factors. With that said, charts one and two show
modest improvement for most nations.
With seasonality a potential issue, we
have looked more closely at year-over-year changes in the ratio. While this could
result in missing a turning point, reducing Europe’s debt/GDP is going to be a
very long-term process, more akin to turning an aircraft carrier than a 19 foot
ski-boat. Given significant absolute debt levels, low growth, and an inability
to devalue their currency, peripheral nations will find climbing out of their
debt overage an enormous, and indeed long-term, project. As such, missing the
exact moment when positive change occurs, if it occurs, isn’t likely to be
problematic.
Year-over-year, Eurozone debt has grown
a relatively modest 2.7 percentage points, from 89.9% of GDP to 92.6% over the
12-months ending in September. However, for most of the periphery, debt/GDP
increased significantly. Cyprus, Greece, and Spain all experienced double-digit
increases in debt relative to the size of their economies. Ireland, Italy, and
Portugal saw smaller, albeit significant, increases in their debt ratios as
well.
Another way to look for change in the ratio is to review the slope of the debt/GDP ratio to see if it is steepening or flattening. Only in Ireland, where the ratio has essentially remained stable over the last three quarters, do we see signs of a potential peak. The modest decline in the 3rd quarter aside, the rate of change in the ratio in Portugal remains relatively constant as it does for Greece, Spain, and Italy. That of Cyprus appears to be accelerating. As such, we must conclude, that, the periphery has made little progress in reducing its debt. There have been very modest signs of growth, ECB policy has significantly lowered the cost of debt for those with market access, and others continue to receive aid. Yet for most of these countries, nominal GDP growth is likely to remain below the cost of debt over the next two years and most will continue to run primary deficits (i.e. they will run deficits before taking into account the cost of funding). As such, most will see their debt/GDP ratio continue to climb and any progress at lowering it will be very, very hard to come by, leaving them susceptible to it climbing again, and rapidly, with any exogenous shock to the economy. In short, it is far too early to suggest that these nations have put their debt troubles behind them. As we have noted before, the European debt crisis isn’t dead, it’s just hibernating.
Please note that in the chart for Greece, the brief, but sharp, decline was due to restructuring of the nation’s debt in March 2012. Despite that restructuring Greek debt/GDP reached new highs just 18 months later.