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2014: a crucial year for the periphery

The euro area is continuing to recover. The core countries have already been growing for several months now and the periphery countries, lagging behind somewhat, are starting to build up steam and gradually exit the recession. Some of them have required financial aid to be able to tackle the necessary reforms, put right their banking system and set public debt at a sustainable level. Given this situation, 2014 will be a crucial year for Europe's periphery: Ireland and Portugal are coming to the end of their respective bail-outs, Greece is at the midpoint of its second aid package although there are doubts to whether it has enough funds for the coming year and, lastly, Spain will have come to the end of its bank bail-out without having used up all the funds made available. Consequently, if all goes as expected, 2014 could be the year when the sovereign debt crisis truly comes to an end. Will this be the case?

The imbalances of the Portuguese, Greek and Irish economies have been corrected on three different fronts: sustainability of public debt, private sector deleveraging and gains in competitiveness. The first has been one of the pillars of the three financial bail-outs, either because it was the main problem of the country from the start (as in the case of Portugal and Greece) or because it has been called into question by resolving another imbalance (as in Ireland's case, where the origin was a banking crisis caused by a real estate bubble). In any case, the progress made in terms of fiscal consolidation has been significant in the three countries mentioned, with reductions in their public deficit of more than half since 2010. The largest correction has been carried out by Greece, reducing its debt by 15.6% of GDP to 4.1% in four years. It will also be the first country to achieve a primary surplus at the end of 2013. Portugal and Ireland are expected to follow suit in 2014. This fiscal consolidation effort has helped to slow down growth in public debt, which is even expected to fall as from 2014 for the three economies.

The private sector of these three countries is also carrying out significant adjustments, both households and firms and also the banking sector. Of note for the latter is the recapitalisation carried out by banks in 2012 to meet the capital target (Capital Tier 1 ratio) of 8%, although in most cases this has required public funds. In spite of the advances made to improve solvency, Greek, Portuguese and Irish banks are still under pressure in an adverse operational environment and with high default rates that continue to rise.

Deleveraging is somewhat slower in the case of households and firms. In Ireland, the country with the highest levels of debt, only household debt has started to fall to any significant extent: from its level of 123% of GDP reached in 2009 it has fallen to 106% but is still far from the 65% of the euro area as a whole. Non-financial firms, with notably higher levels of debt, namely 206% of GDP in 2013 Q1, have yet to start deleveraging. The situation of Portugal and Greece is not very different. Although starting from lower levels of debt, the progress they have made to date has been practically zero. Specifically, in the case of households, indebtedness stands at 91% of GDP in Portugal and 73% in Greece. Greece's business sector has comfortable levels of debt, namely 75% of GDP (24 pp below the average for the euro area) but in Portugal, where the ratio is at 164% of GDP, adjustment has yet to begin.

The reforms implemented under the respective bail-out programmes, especially in terms of fiscal consolidation and structural improvements, have helped to kickstart the economic recovery for those students in a better position, Ireland and Portugal. The star pupil in this case is Ireland, whose growth has been above the average for the euro area since 2011. The recovery is slower in Portugal, with the foreign sector maintaining its tone thanks to the good performance by exports resulting from notable gains in competitiveness. Of the three periphery countries, Greece is the one with most difficulty in returning to positive growth rates. Its huge drop in domestic demand is still affecting the economy's capacity to recover and, although there have been significant gains in competitiveness, exports have not responded as positively as in the rest of the periphery countries.

The figures presented by Ireland therefore mean that it can face the last phase of its programme with the troika, which ends in December 2013, with certain confidence. In fact, the Irish treasury has already been able to meet the borrowing needs forecast for 2014, allowing it to rule out requesting a precautionary line of credit to guarantee its net lending once the troika's bail-out comes to an end. However, the country still has large imbalances that it must continue to correct. The three challenges it must not lose sight of are to complete deleveraging, restructure the banking sector and reduce unemployment.

Portugal's situation is less favourable. Doubts still reign regarding its capacity to successfully complete its aid programme with the troika by June 2014. The improvement in economic activity of the last few quarters suggests that Portugal may be able to achieve rates of growth that help it to stabilize its public debt at a sustainable level. However, this must be accompanied by irreproachable fiscal discipline. Solid commitment by all political parties to the bail-out programme is crucial in order to restore investor confidence but there is little time left to achieve this. Over the coming months the Portuguese government should show convincing signs that it can start to pre-finance its borrowing needs for 2014. In this respect, Portugal's possibilities to access the markets are a slightly more limited than those of Ireland.

Lastly, regarding the pupil that could do better, namely Greece, there are new borrowing needs for 2014 and 2015 not being covered by the troika programme, totalling 10.9 billion euros. 2014 will not be the year when Greece stops receiving aid from the troika since, in principle, it will still be under the latter's supervision for the next three years. Moreover, debate is likely to continue regarding whether the current bail-out programme is actually enough.

In short, 2014 is unlikely to see a definitive end to the sovereign debt crisis but all the evidence suggests that some active sources of risk may be neutralised such as Ireland and perhaps even Portugal, and a start could be made to control those sources that have remained uncontrollable for some time now: namely Greece. The key lies in ensuring that any uncertainty and fear in the markets does not spread to other economies, as has been the case during the last year when rumours of another bail-out in Greece did not affect the other periphery countries. If all goes according to plan, in 2014 we will be a little closer to full recovery in the euro area and to the end of the sovereign debt crisis once and for all.

Ariadna Vidal Martínez
European Unit, Research Department, "la Caixa"

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