Three interrelated factors are critical to the Eurozone’s growth performance in 2014 and beyond: accelerating business investments, stabilizing credit conditions, and decreasing uncertainty.
2013 was a year of transition for the Eurozone. On the positive side, a seemingly endless recession came to an end, and tepid growth set in. Moreover, the main early business cycle indicators have been showing a clear and intact upward trend since the middle of the year. On the negative side, the overall growth rate for 2013 was still negative (–0.4 percent). Going forward, most forecasts for 2014 foresee a growth rate in the region of around 1 percent.
Growing at this speed will not be enough to heal the wounds of the recession.
Growing at this speed will not be enough to heal the wounds of the recession. Eurozone citizens are poorer than they were before the financial crisis. Between 2008 and 2013, GDP per capita fell by 3.5 percent. By comparison, US GDP per capita rose by 1.2 percent over the same period. While some members of the larger European Union, especially Poland, could substantially increase their GDP per capita over the same period, of the Eurozone members only Slovakia experienced an increase of more than 5 percent. Countries such as the Netherlands, Spain, and Italy saw their wealth decreasing between 5 and 9 percent over the last five years.1
Several well-known factors, such as ongoing deleveraging and fiscal consolidation, are still a drag on the recovery in the Eurozone. However, looking ahead, things could also play out more positively than projected. The strength of recoveries is rarely accurately predicted. The remainder of this article considers what would need to happen for growth in the Eurozone to exceed expectations. Three interrelated factors are critical for the Eurozone’s growth performance in 2014 and beyond: accelerating business investments, stabilizing credit conditions, and decreasing uncertainty.
So far, the Eurozone recovery has been almost exclusively export-based (see the second quarter edition of Global Economic Outlook).2 Higher competitiveness in the tradables sector helped the crisis countries to substantially improve their current account balances. The resulting higher independence from foreign capital contributed considerably to the relative calm on the financial markets in 2013. At the same time, increasing exports drove growth in Northern European countries, but they resulted in heightened dependency on emerging markets.
A profoundly low rate of business investments has the biggest potential for positive surprises. Compared to the pre-crisis year 2007, investments as a share of GDP fell from 21.8 percent to 17.2 percent in 2013. Behind that decrease are factors like declining construction investments in countries such as Spain, which have experienced a real estate bubble. However, investment in equipment, which is decisive for economic growth potential and productivity, continues to fall in the Eurozone (see figure 1).
Weak investment rates are not limited to the crisis countries. Despite a period of economic strength, Germany’s investment rate, overall and in equipment, has been much lower than the Eurozone average over the last decade. For the most part, Germany’s substantial savings have been invested abroad rather than domestically. Given the ongoing investment weakness in Germany, there is the danger that the low interest rates, currently at 0.25 percent after the latest interest rate decrease in November, are mainly used to finance construction investments, thereby possibly feeding a new real estate bubble.
However, there are signs that investment weakness in Germany could be coming to an end, which would considerably help the Eurozone recovery as a whole. The investment plans of German CFOs for 2014 reached clearly positive territory and are accelerating for the first time, according to the Deloitte CFO Survey taken at the end of the third quarter (see figure 2). The results, reveal that investment propensity doubled and CFOs plan to use their high capital reserves to fund investment at home and abroad.3
The crisis countries are also at a critical juncture in terms of investments. Higher competitiveness in their tradable sectors could increase their exports and improve their current accounts. In a second step, improved export performance should stimulate investments, which contributes to the upside potential of the Eurozone economy.
The process of restructuring banks in the Eurozone and increasing systemic financial stability is far from finished.
The fragility of the Eurozone banking system has significantly obstructed growth. The Eurozone has been severely affected by the financial and banking crises because European corporates rely on credit to a much higher degree than, for example, US firms. Investment, therefore, has been held back by difficult financing conditions in the crisis countries and the fragmentation of European financial markets during the euro crisis.
The process of restructuring banks in the Eurozone and increasing systemic financial stability is far from finished. The fragmentation of bank funding markets continues, bank restructuring remains incomplete, and discussions about the form of a banking union are ongoing. 2014 will see the European Central Bank assume responsibility for supervising banks and reviewing asset quality. The goal of the review is to increase transparency about bank balance sheets and repair them when needed.
Nevertheless, while the Eurozone’s banking sector is still vulnerable and financial fragmentation and differing financing conditions pose a very serious problem, several areas are improving. The European Central Bank notes positive developments in systemic banking sector stress as well as in banking funding challenges in stressed countries. The indicator that measures systemic banking sector stress has been decreasing substantially. At the end of 2013, it reached its lowest level since mid-2011, when the crisis intensified. Similarly, average bank funding costs reached their lowest level for more than three years, implying a normalization of bank funding conditions.4
At the same time, credit conditions in the Eurozone as a whole are improving, thereby supporting higher investment activity. According to the Bank Lending Survey of the European Central Bank, banks expected an easing of credit standards on loans to enterprises in the fourth quarter for the first time since 2009.5 In other words, credit conditions and credit supply are stabilizing. Loan demand, on the other hand, is still weak. Nevertheless, if there is further progress on both dimensions, systemic stability, and credit conditions, a stable basis for a stronger recovery would be established.
The length and the depth of the Eurozone recession was, to a high degree, due to uncertainty regarding the future shape of the Eurozone and the tail risks associated with it. This uncertainty affected consumers, corporates, and financial market participants alike, holding back consumption and investments and endangering financial stability. It also reinforced the effects of credit constraints and weak balance sheets.
Current developments suggest that uncertainty is on the decline. At the end of 2013, it is much lower than in the beginning. In the financial markets, the spreads of the Eurozone’s crisis countries vis-a-vis German bunds have narrowed substantially since the beginning of the year. For example, the spread of Spanish 10-year bonds over German bunds shrank by around 30 percent.
The same mechanism is visible in the real economy. The degree of uncertainty that German CFOs see themselves exposed to decreased in a remarkable way. Between late 2012 and late 2013, those who felt that uncertainty in the economic and financial environment was high or very high fell to 18 percent from 49 percent. Compared to early 2012, the decrease is even more dramatic (see figure 3).
If this trend continues, reduced macro uncertainty and greater stability could help the Eurozone’s growth in 2014. By releasing catch-up and pent-up growth dynamics, it could lift the Eurozone’s growth above current forecasts.
Investments, credit conditions, and uncertainty are closely interrelated. This opens up the possibility of positive feedback loops among them. For example, if political uncertainty further decreases and credit conditions improve, a rise in investments is set to follow. For growth in the Eurozone to exceed expectations in 2014, further positive changes in each of these three areas would be valuable signposts.
EndnotesView all endnotes
- Economic growth in the European Union, Lisbon Council 2013, http://www.lisboncouncil.net/publication/publication/100-economic-growth-in-the-european-union.html.
- Alexander Börsch, “Eurozone: A silver lining on the growth horizon,” Global Economic Outlook, April 15, 2013, accessed December 16, 2013, http://220.127.116.11/articles/ eurozone-a-silver-lining-on-the-growth-horizon, accessed December 16, 2013.
- CFO Survey 2/2013, Unternehmen erhöhen die Schlagzahl, Deloitte, http://www.deloitte.com/assets/Dcom-Germany/Local%20Assets/Documents/18_Growth%20Platforms/CFO-Services/CFO_2-2013.pdf.
- European Central Bank, Financial Stability Review, November 2013.
- European Central Bank, The Euro Area Bank Lending Survey, 3rd quarter, October 2013.