17 July 2011

Hey Europe, What Is Going On? (Part 1)

Greece about to default, Ireland’s and Portugal’s government debt junk or almost junk, Euro area’s third-largest economy Italy in crisis, the pain of unemployment hitting new records in Spain, Belgium’s AA-plus rating outlooks negative, IMF warning Germany about less rosy future, bank funding crunch overshadowing EU bank stress test results, European Central Bank (ECB) in need of raising more capital – hey Europe, what’s going on? Is that all or is there anything more in the pipeline?

Clearly, when discussing the sovereign debt crisis in Europe, it’s not enough to focus on a small number of countries like Greece, Portugal and Ireland and most recently also Italy only. Instead, we have to take a comprehensive look to all eurozone countries as well as to the other key players in Europe. Furthermore, it’s not only about sovereign debts; it’s at least as much about the financial sector, countries’ economic fundamentals and not less importantly, about politics and social situation.

We have performed a number-crunching exercise and analysis based on the data, forecasts and other information provided by Eurostat and by ECB, by the European Commission in its interim forecast in spring 2011, by IMF in its recent financial stability reports and economic outlooks, by Financial Times in ft.com/marketsdata, Furthermore, we have considered what rating agencies have to say, browsed through quite a bunch of relevant news articles and posts of financial blogs, considered 2010 Annual Reports of some major European banks as well as the recently published results of the 2011 EU-wide bank stress testing exercise. In addition, we have taken a look to the European Financial Stability Facility (EFSF) and to the European Stability Mechanism (ESM) Treaty published on 11 July 2011. All this was with the aim to get a glimpse of what is really going on in Europe, especially in eurozone. The following is a summary of what we have found so far. Of course, there is much more to explore, our work continues and more is to come.

As of now, eurozone consists of 17 countries: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia and Spain.

In addition, we are keeping an eye on United Kingdom (UK) due to its size and importance in European Union, as well as (although in somewhat lesser extent) on Denmark which is located in the heart of Europe, and Switzerland and Sweden due to their currencies that are seen as safe harbours in turbulent times. Switzerland is particularly interesting also because of its two large banks, UBS and Credit Suisse, the combined assets of which exceed country’s economy several times.

Let’s put things into perspective

Sizes of eurozone economies
The total GDP of eurozone countries in 2010 was EUR 9,190.6 billion. The four largest economies (Germany, France, Italy and Spain) formed more than 75% of it at the same time as the ten smallest barely 10% (see Figure 1 below). GDP for UK, the largest EU’s economy outside eurozone, was EUR 1,689.6 billion. These are the numbers against what the economists are used to compare things.

Debt burdens of European governments
Figure 2 illustrates the debt burdens of key European governments. We have selected the six largest eurozone countries plus UK plus the remaining so-called PIIGS countries (Greece, Ireland and Portugal) who have already received financial assistance. According to Eurostat, the aggregated government debt of the chosen eurozone countries (i.e. all countries concerned except UK) in 2010 formed ca.  95.7% of the total general government debt in eurozone, i.e. the vast majority.

The total debt burden of the selected countries exceeds nine trillions of euros. What is to note here, is that the debts of five governments have already surpassed the theoretical point-of-no-return (90% of GDP) including most importantly Italy, the third-largest eurozone economy. But that’s not all: France, the second-largest economy, is actually pretty close to it.

The other in short term even much more pressing matter is the amount of money that governments are going to need in 2011 and in 2012: by amounting to EUR 3,653.2 billion it’s more than one third of the gross debt. Among others, it becomes obvious that funds currently available in the European crisis resolution mechanisms (all together EUR 800bn) are insufficient as soon as Italy is added to the list of those needing assistance. Ok, let’s not run ahead with the conclusions.

In the above table we have also shown the percentage of gross general government debt held abroad which is one of the most watched indicators when the possible liquidity crisis of a government is being discussed. We see that UK stands out on positive side: only 26.7% of its vast debt is not held domestically. All the examined eurozone countries tend to be significantly exposed to what outside investors and creditors are thinking of them; Italy, Spain and Germany somewhat less than the others. What is UK’s phenomenon? Well, it has something to do with its financial sector and its ability to print money. Concerning eurozone countries, however, note that the situation may actually not be as bad as it seems at first: until they have large exposures to each other but have also the political will to defend euro (i.e. bail each other out when needed), the debt held abroad is less dangerous than it would otherwise be. So, who holds the debts of PIIGS countries? But who holds the debts of Germany and France? We will certainly come back to that later.
Government revenues and expenditures, incl. the impact of interest expenses
An overview of the governments’ revenues, expenditures and budget deficits is provided in Figure 3 below. For analytical purposes, we use the same selection of countries and in the same order as in the above paragraph.  

Note that:
* Ireland’s large budget deficit (-32.4% of GDP in 2010) was mainly caused by the bank bailout which cost roughly 30% of GDP.
* Greece’s budget deficit would not be that bad if the government wouldn’t have to pay 14.3% of its revenues for interests.
* In addition to Spain, UK doesn’t appear that good in this picture either: if we exclude interest expenses, it had one of the largest budget deficits in 2010.
* Italy actually looks pretty good based on these numbers.

Top 25 European banks and their Assets to Home Country GDP
Based on the very fresh memory of Ireland, too large and too leveraged banking sector could prove to be quite a killing course for a country’s economy. This is precisely the general issue in Europe: in several countries including but not limited to Belgium, Denmark, Netherlands, Spain, Sweden and Switzerland, the largest banks are larger than the home country’s GDP. An illustration of the assets of top 25 European banks compared to their home countries’ economies is provided on Figure 4 below.

Wow! This is truly an illustration of the too-big-to-fail or even too-big-to-save issue. The total assets of the top 25 banks amounted to 23.5 trillion euros as of at the end of 2010 while the aggregate GDP of the very same ten “home countries” of these banks is/was approximately 10.3 trillion euros in 2010. Notably, the assets of both UBS and Credit Suisse exceed Swiss economy more than two times. Also Dexia, Danske Bank, ING and Nordea Bank seem far too big for Belgium, Denmark, Netherlands and Sweden respectively. What we shall understand is the reflexive relationship between the health of these large banks and Europe’s debt crisis as well as what are or can be the resulting impacts to households and non-financial companies.

This concludes Part 1. Now we should have an idea of the numbers of euros that are in stake as far as Europe’s current woes are concerned.

Up next in this series: polarizations within European economies

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