Nicolaus Heinen of DB Research -
The autumn forecast released by the European Commission on November 7 is more than simply a collection of numbers - it will also influence the economic policy agenda in the EU and the Eurozone. France remains a source of concern.
The autumn forecast paints a mixed picture: the position of the countries stricken by the euro crisis has deteriorated versus the spring forecast.
In the context of running down their budget deficits, most of the euro countries have lost ground. While the outlook for Greece has improved at a low level, the forecasts for consolidation achievements in Spain, Italy and Portugal have been revised to the downside. All these readings are a long way away from the Maastricht target (3% of GDP). The reduction of current account imbalances is also proceeding more slowly than anticipated six months ago. The respective surpluses and deficits for 2012 have widened in comparison with the spring forecast. Last but not least, the labour market situation continues to worsen: the Commission now reports higher unemployment rates for Greece, Ireland, Portugal, Italy and Cyprus. All these countries have double-digit unemployment rates - Spain is stabilising at over 24%.
Budget and current account deficits as well as unemployment may be reduced in the medium term via higher growth. One prerequisite for this is an increase in price competitiveness in the crisis countries which, in a monetary union with fixed exchange rates vis-Ã -vis the other union members, can only be achieved via a devaluation in real terms. A look at the real effective exchange rates shows that this real devaluation in the crisis countries is likely to be much more pronounced than forecast as recently as spring. However, to create growth in crisis countries this on its own is not enough - especially not if risks to global growth keep a lid on exports and structural reforms fail to create confidence and attract investors to the extent desired. And this is why the Commission has revised down its growth forecasts for most countries (except for Germany). According to the Commission, the Eurozone economy will expand by only 0.1% in 2013 - a 0.9 percentage point correction since spring.
France in particular is a cause for concern. France's economy is in the doldrums, with still poor growth prospects and weak export development. Back in spring the Commission had (in its Alert Mechanism Report) already criticised a lack of price and non-price competitiveness, declining shares in world export markets, unprofitable enterprises and low investment incentives. France is forecast to run a deficit of over 3.5% for 2013 and 2014 - this is a far cry from the French government's original target of returning the budget deficit to below the Maastricht benchmark in 2013. There is no sign of relief in sight: discussions over the recent proposal by the Gallois Commission, which would like to make France more competitive via supply-side reforms, are unlikely to produce a compromise. At least an initial understanding has been reached on corporate relief to the tune of EUR 10 bn - a zero-sum game for the time being, since corporate taxes were temporarily increased last summer as part of a consolidation package. Nobody dares to call into question the statutory 35-hour working week.
The autumn forecast will directly influence the economic policy of the EU member states - via three different channels.
1) Economic agenda-setting: First of all, the Commission's numbers provide the quantitative basis for its annual growth report which is to be published at the beginning of the coming year. From this report, the Commission will derive a set of reform priorities for the entire EU, which will be tabled for approval by the European Council in March. The fiscal and economic priorities for the member states will then be set out along the lines of these measures in April in what are referred to as the national reform and stability programmes. In May, these programmes are evaluated by the Commission - at this juncture next spring's forecasts are also factored in. In July, the European Council adopts country-specific recommendations. However, the comprehensive revision of the growth outlook raises general doubts about whether forecasts made in times of exceptional macroeconomic circumstances should still be considered valid as the basis for long-term economic policy recommendations. It is all the more important that they be supplemented with qualitative benchmarks as long-term anchors.
2) Fiscal Compact and debt brakes: Furthermore, the deficit and growth forecasts provide the basis for budget targets that the Commission will set over the coming weeks in the framework of the preventive arm of the Stability and Growth Pact. For signatories to the Fiscal Compact that have already established debt brakes, this adjustment path will be directly integrated into the national legal order.
3) Deficit procedures: Since the Commission has heavily revised its growth outlook downwards, there could soon be increasing calls to water down the deficit reduction requirements for the countries in the excessive deficit procedure - this means: waiving sanctions if consolidation is not on schedule and postponing the target date for deficit correction. The Code of Conduct in the SGP certainly allows both possibilities if economies are shrinking or stagnating with a large output gap (i.e. actual output differs from potential output). Arguments against such action would be provided by a look at the structural deficits, which shows that the recent slump is not explained strictly by cyclical factors alone. However, the Commission's low-key comments about initially wanting to review the overall situation of each country before sending out any reminders suggest it would tend to be lenient.
Even if it were to stand firm: a look at the table shows that seven of the 17 Eurozone members are off target. If France were among them, powerful coalitions could soon be formed to thwart an early warning or sanctions by virtue of a qualified majority. Thus, it is to be feared that, despite the promising revamp it underwent last year, the Stability and Growth Pact might not be applied as rigorously as hoped.
It appears that Europe is currently at least as far away from having the potential to impose credible sanctions on budget offenders as it is from achieving consistently sound budget figures.
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