Confidence vs. reality on Europe’s fiscal front
What do Poland, the European Union’s brightest economic light, and Greece, its dimmest, have in common? Both have plans to cut their budget deficits to the Union’s prescribed 3 percent level by 2012, and both of those plans depend on a lot of ifs.
I can already hear cries of protest from Poland, the only EU member to show any growth at all last year. It that has taken great pains to distance itself from more troubled EU states and is extremely proud of its growth results, with Prime Minister Donald Tusk recently telling the Financial Times: “Who would have thought we would see the day when the Polish economy is talked about with greater respect than the German economy?”
But the comparison still works, not only because Poland and Greece have promised to shrink their deficits so quickly — Greece from an expected 12.7 and Poland from around 7 percent this year — but also because they are depending on growth forecasts that may not materialise. Both stories are also emblematic of a theme sweeping across Europe — an effort by governments to build confidence over fiscal consolidation plans in an uncertain recovery.
Tusk, and Poland, have a lot to crow about. While Greece is struggling to maintain credibility and tackle its huge public debt load, Poland is expected to grow by 2.5-3.0 percent by many economists. Warsaw has a relatively low debt pile of around 50 percent of gross domestic product, compared with around 120 percent for Greece. Investors have flocked to Polish stocks and bonds, driving the zloty currency 27 percent higher from mid-crisis lows hit last year. And they see more upside on the horizon because, with a living standard of only 56 percent of the EU’s average, the country is seen as a sure bet for eventual convergence to near the levels seen in more developed EU states.
Greece is clearly a different story. Its economy is expected to shrink this year and the government has embarked on a programme of eye-watering budget cuts that have prompted strikes and protests among civil servants. While Poland has had no trouble borrowing on international markets and at home, Athens must still borrow 20 billion euros before May at much higher interest rates than before the crisis.
Their approaches are different but have one common factor: growth forecasts that many economists and policymakers see as unrealistic. Greece is depending on tax hikes, cuts to pensions and public wages, and other austerity measures. But a large part of is solution is based on a forecast that growth will resume in 2011 and reach 2.5 percent by 2013.
The European Commission has endorsed the plan, but has also cast doubt on the growth outlook, saying it sees Greece contracting by 2 percent this year, versus the government’s 0.3 percent forecast. The Greek government has since approved a third package of belt-tightening that both it and the Commission say should allow it to make the required 4 percentage points of GDP in fiscal cuts this year. But economists are still extremely cautious, and say risks include both that the government won’t be able to meet its tax revenue targets, or if it does, it will further depress the economy.
In Poland, no one has been so dismissive. Warsaw is depending on proceeds from selling stakes in state owned firms to plug its budget holes. The country also has constitutional debt limits that trigger spending cuts if broken, although so far most experts say the government will resort to moving items off budget and using other creative ways — potentially even changing the law — to avoid such drastic measures.
It sees growth of 3 percent this year, followed by an expansion of 2.9 percent in 2011. But the Monetary Policy Council has cast doubt on those forecasts and its chief Slawomir Skrzypek has called cutting the gap to 3 percent in 2012, from an estimated 7 percent this year “hard… to imagine”. That was echoed by the International Monetary Fund on Monday, which called the plan “too ambitious, considering that the economic recovery is incipient and still uncertain”.
What is most interesting about Poland and Greece is they can serve as brackets to much of the rest of the EU, nearly all of whose members are struggling to differing degrees of sluggish growth prospects and ballooning budget deficits.
Although perhaps not a big surprise, the European Commission is expected to rap Britain this week by saying its fiscal consolidation plans are not ambitious enough and are based on growth forecasts that might be too optimistic, according to a draft obtained by Reuters. Another story is Ireland, which faced as extreme a deficit challenge as Greece, albeit with a lower debt level, but has regained the market’s confidence with draconian austerity measures, while Portugal and Spain are still somewhere in the middle. It will be interesting to see what the Commission makes of fiscal consolidation plans of Austria, Germany, Belgium, Spain, Finland, Ireland, Italy, France, the Netherlands and Slovakia, on which it will also publish assessments on Wednesday.
It’s important to note that few analysts foresee an imminent multi-sovereign default among developed countries. But there is still wide concern over debt in the West that may spiral upwards from already high levels due to pension costs for aging populations and an unclear outlook on how quickly, if ever, growth will creep back to near pre-crisis levels. Moody’s even warned on Monday that the triple A ratings of the United States and other major Western nations may be at risk.
So are governments backing away from their fiscal consolidation programmes? Not really, and it’s not difficult to understand why. For starters, over-optimistic growth assumptions are not in any way unusual in the EU and some countries have systematically based budgets and stability programmes on inflated forecasts that fall short in practice. But more importantly, for policymakers, this year appears to be less an exercise of realistic accounting than an effort to control expectations long enough for the recovery to take hold — an idea put forth by European Central Bank President Jean Claude Trichet on Monday.
“The keyword for 2010 is confidence,” European Central Bank President Jean Claude Trichet said on Monday. “It is now the task of private and public decision makers to work together to improve confidence in our financial system and the economy to ensure a stable recovery.”