From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. If you are interested in Morningstar featuring your content, please contact Online Editor Holly Cook (holly.cook@morningstar.com). In this video, Robin Bew, Editorial Director and Chief Economist at the Economist Intelligence Unit, shares his views on the deepening sovereign debt worries in the PIIGS. While it looks like the euro is going to muddle through this crisis and no one is going to opt out of the single currency, it is very important to recognise that countries have that option, Bew says.
Tony McMahon: Hello and welcome to the Global Forecast from the Economist Intelligence Unit. I'm Tony McMahon and as ever I'm joined by Robin Bew. Robin, does what's happening to Portugal and Ireland's troubled economies really matter at a global level?
Robin Bew: Well it matters not because Portugal and Ireland themselves are particularly significant in terms of global economic growth. I mean they're both very small economies, but the contagion story clearly matters. The idea that Ireland and Portugal could potentially drive financial markets in a way which they destabilise bigger economies like Spain or indeed, the entire eurozone or even cause a double dip for the OECD economies in general, that of course matters.
Ireland and Portugal themselves are very, very small, but the consequences for the rest of the world potentially could be very big.
McMahon: Do you think that the euro really is facing a survival risk or will it muddle through with the PIIGS being bailed out?
Bew: Well we think it is going to muddle through and we certainly don't think that anyone is going to leave, but I think it is very important to recognise that countries can leave. That they can't be forced out by trading activity in a way that, say, countries are forced off the exchange rate mechanism, but certainly they can opt to leave and you can imagine if the economic situations got bad enough, they may decide to leave.
I think it's also important to recognise that the leavers would not necessarily be people like Ireland and Portugal. They could indeed be someone like Germany who decided that they didn't like the bailouts that were being necessary in order to hold the eurozone together.
But our view is that actually they will muddle through and that muddle through will require bailouts, it will require more largesse from institutions, from other big economies. But ultimately, it's not in anyone's interest for the euro to fail, so we think it will succeed. The political will is there, but the price may be very high.
McMahon: What do you think the stance of the ECB is likely to be in the medium-term?
Bew: I think it's pretty clear that interest rates are going to stay low in order to offset all the fiscal tightening that we're seeing. Now not all commentators think that. Some are worried the ECB may tighten monetary policy if inflation starts to rise, but we think that's pretty unlikely given the fiscal situation. The much more interesting question is going to be ECB liquidity injections and the support that it provides into the banking system. They've been pumping a lot of money in order to support banks in general and Irish banks in particular.
Now recently, it has become clear that their view on this is starting to change. They're certainly not reducing the amount of money they're pumping in but the pace of growth in liquidity injections is clearly slowing and their view seems to be that the next step for a country like Ireland ought to be to ask for financial assistance for support. In other words, for a bailout. The next step shouldn't be for the ECB to pump in yet more cash because they're very worried that if they continue to provide money to the banking system ad infinitum, fiscal and monetary policy become very blurred and essentially fiscal restraint within the eurozone becomes a thing of the past.
So they don't want to contribute to governments letting rip within the eurozone, so they're very keen that the next step is a bailout; not the ECB pumping yet more money in.
McMahon: Do you think that Ireland's woes have given austerity packages a bad name?
Bew: Yes, I think they probably do. Certainly politically they give them a very bad name. Ireland is putting itself through a tremendous amount of pain. You would have to say that traditional economist would say Ireland did all the right things. You know, wore the hair shirt, cut public spending very aggressively, all the things that other countries have found very difficult to do.
If you look back six or eight months and the contrast between the narrative that most commentators spun around Ireland and the way they were tackling their problems and the story around what was going on in Spain or what was going on in Portugal or even what was going on in Greece, Ireland was viewed as being doing all the right things.
If they have to go for a bailout now anyway, then I can see the political story around the sense behind the cuts, is going to be a very difficult one to spin. But yet nonetheless, ultimately, a bailout is only a temporary fix for a long-term problem.
Ultimately, Ireland had to get its fiscal situation under control, so the true story is they had to tighten policy as hard as they did. But if they get a bailout anyway, if the population in Ireland sees that they went through all this pain and they still had to resort to getting bailout from the EU, then I'm sure the political story is going to become very difficult for them.
But ultimately, there's no way out. They are running a fantastic large government deficit with a very high debt stock. They have to spend less and tax more.
McMahon: What's going to bring calm to the bond markets?
Bew: I think the only thing which is really going to bring calm to the bond markets is when you see deficit numbers start to move very significantly in the right direction and bond markets start to get some confidence that debt stocks are going to start to come back down again.
Now that's quite a long way from where we are today for, say, someone like Ireland. This year their deficit is going to be horrendous because of the cost of the bailout to the banking system. Next year it should be a lot smaller because of course those costs won't reoccur, but there's a real question mark over whether they get the deficit down as fast as they're planning to, and that's a similar story for Spain, for Portugal, for Greece - how quickly will these cuts come into effect?
I think the bailout story is actually not something which is going to really provide much of a stop to the bond market because of course if Ireland has to go for a bailout, the immediate next question is going to be well Ireland did all the right stuff and they need a bailout anyway, so what about Portugal, what about Spain and a real sense that the whole problem could be spreading.
So I think the only thing which is going to give bond market participants real confidence is to see deficits substantively move down, but that's going to take a long time from where we are today. I mean it's certainly at least 12 months away from that and probably longer.
McMahon: Is there any scenario where the eurozone's problems become a catalyst for the double dip, which is a scenario that has been written off a bit of late?
Bew: Well clearly for all the worst affected countries, a double dip is a racing certainty. It's a question about what happens to the eurozone in general and then what happens to the world.
At the moment what we see is that Germany and a few other smaller countries are keeping the eurozone moving forwards actually quite nicely, because German trade with the emerging markets is actually quite strong. Germany seems to be shrugging off pretty well these problems in the peripheral countries, which is important to recognise are very small.
Now you could see a more significant problem arising within the eurozone if you saw a major financial crisis, but of course, all policy at the moment is designed to head that off. So the bailout that we're probably going to see for Ireland and possibly going to see for other countries to is designed to prevent a massive financial shakeout of the sort that we saw a couple of years ago or so.
So I think probably policy will be sufficient to prevent Germany from being very badly affected and really you would need to see a country like Germany run into problems before we started asking questions about the emerging markets, about America. So I think we're probably not going to see the double dip driven by what's going on in Ireland and Portugal.
McMahon: Crossing the Atlantic, with a new political carve up on Capitol Hill, you don't think that the low longer term interest rates will cancel out the diminishing fiscal stimulus?
Bew: No, not really. I mean long-term interest rates are relatively low and have been for some time, although of course they keep bobbing around. Now with a change in the complexion on Capitol Hill, it seems pretty likely that fiscal policy will be modestly tighter than it was before, so long-term bond yields will probably be a bit lower.
But I think the key story is that the fiscal stimulus is going to ebb away. That's going to be much more important. There's a real question about how important additional monetary stimulus can be at this time and that's a debate about long-term interest rates. There's a debate about QE in general actually; about whether QE2 is going to be as effective as QE1 was.
So it seems to us that the real story, or the two main stories are withdraw the fiscal stimulus and the debt overhang that we see in the private sector and those things are going to act as drag on growth and I don't really see monetary policies being able to fully offset those things. Although of course it can partly offset and we think QE2 will have some positive affects, but not enough to offset the problems that we see in fiscal stimulus.
McMahon: Thank you Robin. Well to find out whether the eurozone's PIIGS will be led to the bailout trough, join us again next month on the Global Forecast. Until then, thank you and goodbye.
