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September 4, 2014

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Russia sanctions could harm European economy

IN the second quarter, economic growth in the eurozone slowed to a halt, even before the impact of the sanctions imposed on and by Russia over Ukraine.

For 2014 as a whole, the eurozone’s growth is expected to increase to 1 percent but the recovery is fragile and downside risks have grown. Inflation has plunged to a 4-year low, which keeps consumption low and investment subdued. Europe’s core economies performed dismally. Germany’s economy contracted, France’s continued to stagnate (-0.1 percent) and Italy’s took a dive.

In Germany, foreign trade and investment were the weak spots. The country could still achieve close to 2 percent growth in 2014-2016, but then growth is likely to decelerate to 1.5 percent by late decade.

In France, President Francois Hollande has already pledged 30 billion euros (US$39.4 billion) in tax breaks and hopes to cut public spending by 50 billion euros by 2017.

Nevertheless, French growth stayed in the 0.1-0.2 percent range in the first quarter. Fiscal austerity and falling consumer confidence are preventing domestic demand from rebounding, while investment and jobs linger in the private sector. Pierre Gattaz, head of the largest employers union, has called the economic situation “catastrophic.”

At a standstill, Paris has all but scrapped the target to shrink its deficit. Before his resignation, Prime Minister Manuel Valls intensified reforms, which in April included an additional 11 billion euros in tax cuts for companies and households.

Valls reshuffled his government by replacing his left-wing economy minister Arnaud Montebourg, who has been blasting German Chancellor Angela Merkel’s austerity doctrine and President Hollande’s economic policy, with the ex-banker Emmanuel Macron, who was behind Hollande’s pro-business agenda. The new stance is redefine austerity vis-a-vis budgetary reforms. As a result, Paris hopes to soften Eurozone budget rules next month.

Back to recession

Meanwhile, Italy has fallen back into recession. To sustain his bold economic reforms, Prime Minister Matteo Renzi now needs a whopping 32 billion euros to overhaul the labor market, 18 billion euros for unemployment benefits and 13 billion euros for infrastructure projects. Italy and France are coping with similar ailments.

In both, fiscal adjustment is strangling domestic demand, while exports suffer from deindustrialization, erosion of competitiveness and the strong euro. Although Europe remains significantly behind the US in productivity growth, the euro remains at US$1.31 today.

Since 2011, Brussels has argued that “the worst is behind.” In reality, European debt has increased. General government gross debt as a percentage of the eurozone GDP soared from 70 percent to 93 percent in 2013.

In Italy, the ratio has increased by a third to 133 percent. In Spain, it more than doubled to 94 percent; in France, it rose by a fourth to 94 percent. In small crisis economies, the debt — Greece (175 percent), Portugal (129 percent) — remains at threat levels.

In 2014, the eurozone growth rate will linger at close to 1 percent and it could remain at less than 1.5 percent through the rest of the decade.

As European Central Bank chief Mario Draghi recently alluded, persistent disinflation is driving the ECB away from strict austerity policy.

Unfortunately, ECB is waking up half a decade too late. The unemployment rate remains at 11.5 percent and prohibitively high in Greece (27 percent) and Spain (25 percent), respectively.

But it is the sanctions on and by Russia that pose the greatest downside risk to Europe, Russia’s greatest trade partner, which is highly reliant on Russian oil and natural gas.

In the financial sector, European banks had some 75 percent of Russia’s foreign bank loans in late 2013. Any effort by the West to take the current sanctions to still another level could push Europe into a triple-dip recession.


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