When we talk about ‘economic recovery’ in the eurozone, what does it mean and which factors need to be taken into account?

In the wake of the Greek debt crisis, eurozone nations are under pressure to get their public finances under control. Recovery is different from country to country, but there is one thing they all have in common: everyone is desperate to cut their government spending to reach the EU’s official limit of 3% of GDP. But too much austerity – slashing here and cutting there – could in turn hurt the already fragile recovery. The balance has to be right.

Since the beginning of the year, the euro has plunged more than 15% against the dollar due to investor concerns that the Greek deficit crisis would spread across other EU member states and that the monetary union could collapse.

The eurozone debt crisis is the biggest worry, not only to the eurozone, but also to countries like the UK, where manufacturers look upon their key export market with desperate hope that the eurozone debt crisis does not derail growth.

The official first quarter growth in the UK was 0.3%, and growth in the following two months seems likely. The economy is forecast to grow 1.3% in 2010 and 2.6% in 2011. However, there are a number of factors that are impeding growth in the coming months. For one, there is the spill-over effect from Greece’s debt crisis which is affecting the UK as the sterling has risen.

Another problem for the UK is its fiscal deficit as bringing the deficit under control will take years. Billions of cuts are already announced, mainly spending cuts and tax rises. But the UK’s budget deficit is lower than feared and indicators show that the country might be over the worst of the financial crisis.

In Germany, the Frankfurt-based Bundesbank announced in June that GDP will expand 1.9% this year and 1.4% in 2011. The ‘main driving forces’ for recovery in Germany will be exports, the Bundesbank said. In June, Germany announced an austerity plan worth €80bn by 2014.

Germany is therefore at the forefront of spending cuts, and France has announced an austerity plan, too. It involves €45bn in spending cuts over the next three years to cut their public deficit back down to the EU’s limit of 3% of GDP by 2013 after a record deficit of 8% of GDP this year. The International Monetary Fund (IMF) is forecasting that the French economy will grow by 1.5% this year.

PIGS (Portugal, Italy, Greece, Spain)
When Greece joined the EU in 2001, its government went on a spending spree and public spending soared. Tax evasion was also widespread, and Greece found itself unable to cope with its huge debt and a deficit four times higher than EU deficit rules.
For Greece, now burdened by about €300bn in debt, it all depends on following the austerity measures imposed by the EU and the IMF on the one hand and restructuring on the other.

For weeks the euro has been battered and some even started to fear the break-up of the eurozone. But in May, Greece agreed to a three-year austerity and reform programme as part of a deal with the EU and the IMF in exchange for a €110bn loan package, potentially the biggest ever bail-out of a country, to help the country meet its financing commitments.

According to the Greek Finance Minister, George Papaconstantinou, Greece’s budget gap narrowed by around 40% in the first five months of the year, while revenue was up 8% and spending down by more than 10% in the same period. This indicates that the contraction did not hit the country as hard as was feared. Nevertheless, Greece’s economy is expected to shrink 4% this year.

In the middle of June, teams from the European Commission (EC) the European Central Bank (ECB) and the International Monetary Fund (IMF) visited Greece and reported positive fiscal developments such as a firm expenditure control in the state budget; progressing structural reforms in areas of local administration, privatisation, labour market and tax administration; and progress in the financial sector with the establishment of the Financial Stability Fund and liquidity in the banking sector remaining adequate.

Spain was the last major economy in Europe still in recession at the end of last year. The country’s economic problems were caused mainly by the collapse of a huge real estate bubble.

Fending off a Greek-style debt crisis, Spain introduced an austerity package in May, aiming to slash a deficit of 11.2% of GDP to 6% by 2011 and to 3% by 2013. Spain also announced sweeping reforms to its labour laws that it hopes will stimulate growth. The reforms will make it easier for employers to reduce the hours that staff work during downturns.

In June, Spain’s economy ministry said that it has not and will not make a request for economic aid from the EU, but rumours to the contrary are persistent.

The economic situation in Spain is certainly very serious and high unemployment figures underline that fact, but market indicators show that investors see the situation in Spain as less serious than that of Greece or Portugal.

The Portuguese economy is mentioned, more often than not, in the same breath with its Spanish neighbour. But according to the OECD, Portugal’s economy is expected to expand by 1% this year and has already registered 1.8% year-on-year growth in the first quarter of this year, marking the first positive GDP figures since 2008. With a budget deficit of 9.4% of GDP last year, the Portuguese government has taken efforts to slash its deficit to 4.6% of GDP in 2011. Its citizens took to the streets in May after drastic tax measures were announced ranging from 1 to 2.5%. The OECD also urged Portugal to carry out ‘deep reforms of the national economy’.

Italy has the highest public debt ratio in the EU that is forecast to reach 118% of GDP this year. In May, Prime Minister Berlusconi approved an austerity package of €25bn for 2011 and 2012. The measures include a freeze of public sector salaries for three years, a fight against tax evasion and a cut of 10% to ministerial budgets. But Italy’s budget deficit is only about half that of many other European countries while growth forecasts for 2011 were lowered to 1.5% from 2%.

Road to recovery
Olli Rehn, European Commissioner for Economic and Monetary Policy, insists that countries must go beyond sheer budgetary surveillance, to broaden and deepen surveillance to address macroeconomic imbalances. In a speech in Strasbourg on 19 May 2010, he said: ‘We need to introduce a truly European dimension to economic policy making in Europe. It is not enough to look only afterwards into national decisions. In the EU, in particular in the eurozone, we know only too well that national decisions have an impact far beyond national borders. There will have to be coordination at European level before those decisions.

‘The divergences in competitiveness and the gap between the surplus and deficit countries of the euro area has widened in the past ten years. This has been a root cause of why the financial crisis hit the EU so hard. We should prevent and tackle emerging problems before they escalate.

‘What the European Commission therefore proposes is to define indicators, agree alert thresholds, and give recommendations and early warnings, if necessary. These indicators can include, e.g., the current account developments, productivity trends, unit labour costs and the employment rate.’