Moody’s: Eurozone recovery ongoing, but reform efforts fading and political risks rising

LONDON

While euro area sovereigns’ ratings will likely remain stable in 2016-17, fading fiscal consolidation, limited progress on structural reforms and an increasingly fluid political landscape limit upside potential and create longer-term risks, said Moody’s Investors Service in a report published on March 18.

According to Moody’s, the credit quality of euro area sovereigns is supported by moderate economic growth and stabilizing debt-to-GDP ratios. The main downside risk is of much lower than expected growth in China damaging the global economy, but this is not Moody’s baseline scenario.

“Moody’s expects growth across the euro area to be around 1.5 percent of GDP in 2016. While that is low by historical standards, it will support euro area sovereigns’ credit profiles over the coming year or so,” said Thorsten Nestmann, a Vice President-Senior Analyst at Moody’s and lead author of the report. 

“However, we see little upside to ratings, and a number of clouds gathering,” he added. 

Debt loads remain stubbornly high, with the deleveraging process hampered by a combination of low growth and low inflation. 

“We expect inflation to be around 0% on average in 2016 and to only gradually increase towards 1 percent in 2017. The longer inflation stays low, the longer the deleveraging process will take and the longer the euro area economy will be vulnerable to negative shocks,” added Nestmann.

Moreover, progress on structural reforms has been limited at both national and euro area level, and support for further efforts is eroding against the background of a fluid, unpredictable political landscape which has seen a number of challenges to the established order across Europe.

The UK’s potential exit from the EU could create further obstacles to reform within the EU and also the euro area, and even poses risk to established programs, if it encouraged the growth of anti-establishment or even secessionist political parties in euro member states, according to the report. 


Refugee crisis ‘a further source of disunity’

The refugee crisis is a further source of disunity in the EU that adds another obstacle to longer-term integration within the euro area, impairing the currency union’s capacity to absorb shocks by increasing political tensions within and between member countries, it added. 

“The economic impact of the refugee influx is difficult to estimate because of a lack of clarity on the number, age and qualifications of refugees as well as their ability and willingness to integrate. The European Commission’s estimates that, by 2020, Germany’s GDP could be 0.72 percent higher than under its baseline scenario if refugees have broadly the same skill sets as the German workforce, but less positive (0.47 percent) if refugees’ skill sets are more in line with low-skilled workers,” said the report. 

“Given low inflation and reduced structural consolidation, Moody’s expects only a very gradual reduction in euro area sovereigns’ debt levels in the years prior to 2020,” concluded the report.