THE DRAMATIC fall in Eurozone sovereign bond yields has led some to herald the end of the crisis. We believe this is premature. In reality, the fragile recovery remains under threat from the record debt levels built up during the financial crisis; these debts are not going away any time soon.
Following the 2008 collapse of
Rising government debt and deficits, sometimes financed through official loans from the
This offset the incipient deleveraging, via repayment or default, of private sector debtors. As a result, the debt overhang persists today.
For some Eurozone economies, private sector debt at the end of 2013 was down from its peak, but typically only marginally. To identify the rate of deleveraging, we have calculated a debt reversal ratio for each country, which shows that the most progress has been made by
It is also possible to simulate the potential future trajectory of the deleveraging process for the private sector (households and companies). Assuming recent private debt-to-GDP reductions continue, one possible outcome would be that deleveraging in
There is no simple answer to establish where the new debt equilibrium might lie. An economy's appropriate leverage level depends on a multitude of factors, including interest rates, debt structure, assets owned by debtors, economic conditions, demography and many more. But it's reasonable to assume that a long stretch of deleveraging still lies ahead in most periphery economies. Indeed, public sector debt levels in these countries continue to rise - deleveraging has not even begun.
The fragile economic recovery in the Eurozone is likely to remain subdued in the medium term, and this is reflected in our sovereign ratings. Moreover, if recovery expectations disappoint, this could exacerbate political polarisation, and thus pose an increasing threat to sustaining growth-enhancing, but often unpopular, reforms. Without a swifter economic recovery and growth in employment, popular dissatisfaction could swell. But ultimately, growth will remain dependent on net export performance, as domestic demand will face continuous headwinds.
With the deleveraging process in the Eurozone periphery barely underway, efforts to reduce the persistent debt overhang are likely to stunt growth prospects in the periphery for many years to come. They're not out of the woods yet.
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