Monday, June 21, 2010

Importance of SGIP for North-Eastern economies is low

It is well-known that sovereign defaults in Spain, Greece, Ireland and Portugal would have devastating effects on the financial sectors of the rest of the Eurozone. However, I am convinced that while technically these countries might be insolvent they will not need to default given that the EU/IMF/ECB measures will keep them liquid. As I argued in the previous post (see Intra-Eurozone competitiveness: A solvable task) especially Spain, Portugal and Ireland have a high probability of being able to restore competitiveness and bringing their fiscal deficits back on a sustainable path over a period of 3-5 years whereas the outlook for Greece remains more challenging. The price to pay will be a longer-lasting deflationary recession and a significant increase in the sovereign debt-GDP ratio. However, especially for Spain and Ireland this should not be such a big problem as the starting debt-GDP ratio has been fairly low.
For the banking sector of the other Eurozone countries the fact that SGIP remain liquid and do not need to default while the ECB provides a floor to government bond prices means that the losses they incur are limited. Furthermore, the banks can slowly offload parts of their sovereign debt via the ECB's bond buying and as the EU/IMF refinance the maturing GGBs. Finally, the rising private sector defaults in SGIP will occur over a number of years and the sums involved appear manageable for the Eurozone financial sector.
What remains for the rest of the Eurozone are the economic effects from reduced demand by SGIP. I hear frequently that given Germany is such a big exporter and given SGIP are in a longer-lasting recession, Germany cant grow amid lack of export demand. However, it seems that no one looked at the data as this is just not true.
The table below shows the share of exports going into a particular region relative to total exports for various Eurozone countries. Due to data availability it covers only export of goods but not services (services account for about 20% of all exports). It highlights that the share of exports going to SGIP relative to overall exports is low for most Eurozone countries. In 2008 Germany exported only 6.6% of all exports to SGIP. This has come down further in 2009 to below 6% (EUR48bn vs. total exports of EUR808bn). According to Bundesbank data for services, the picture is the same. Germany exported 6.2% of all exports in services to SGIP in 2008 and 5.6% in 2009 (EUR 9.3bn vs. a total of EUR165.5bn). Except Portugal, due to the high export share going to Spain, only France and Italy have a share of more than 10%. As a side note, the UK – even though not being a Eurozone member - has a share of more than 12% of exports going into SGIP. Overall, demand weakness emanating from SGIP should not have a dramatic effect on the rest of the Eurozone.
Furthermore, exports of goods in the magnitude of more than 20% compared to GDP go outside the Eurozone for Germany, Austria, Finland, Belgium and the Netherlands. Together these countries account for 42% of Eurozone GDP vs. only 18% for SGIP. Furthermore, these exporters have relatively low fiscal deficits and in turn only a limited need for fiscal tightening. France and Italy face a less positive environment as they have a lower share of exports going outside of the Eurozone but will be impacted relatively more by the loss in demand emanating from SGIP and have higher fiscal deficits.
Euro has been weakening especially vs. competitors

Source: Bloomberg

Moreover, the Euro has weakened considerably on a trade-weighted basis which should give a significant boost to the exporters within the Eurozone and therefore for more than 40% of Eurozone GDP. Besides the weakening of the trade-weighted Euro which is based on trade relationships, the Euro has weakened even more vs. the currencies of key competitors. For example the direct trade relationships between the Eurozone and Japan are limited (accounting for 2% of all exports in goods and 3.5% of imports), but Japan is a key competitor in important industries such as cars and machinery. The fall by roughly 30% in the EURJPY cross rate over the past two years means that Eurozone exporters have become significantly more competitive in a short time-period. In turn, Eurozone exports should profit not only from Eurozone goods & services having become cheaper for its trade partners (or alternatively Eurozone corporates being able to increase their margins), but also that Eurozone goods have become much cheaper vs. close substitute products. Both factors should act to boost demand for Eurozone exports.
Consequently, we are likely to face a Eurozone economy where 18% (SGIP) will remain in a longer-lasting recession, 42% (the exporters) face strong external demand and Italy/France (accounting for 38% of GDP) will be able to muddle through. So far, the Eurozone’s current account has been close to zero amid very high deficits in Spain, Portugal, Greece and to a lesser extent France counterbalanced by substantial surpluses in Germany and the Netherlands. Going forward, the Eurozone current account promises to move into a significant surplus amid significantly lower deficits in Portugal, Spain and Greece and very high surpluses in Germany, the Netherlands and to a lesser extent, Finland, Austria and Belgium.

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