Public-sector debt in Europe - Analysis and options

The difficult fiscal situation in Greece will not cause lasting damage to the European Monetary Union, according to a new report by Allianz. Greece’s alarming fiscal situation differs fundamentally from the financial problems in Portugal, Ireland, Spain and Italy. “The problems in these countries are nowhere near as dramatic as in Greece, so a comparison is not justified. There is no danger that European Monetary Union will fall apart,” said Michael Heise, Chief Economist and Head of Corporate Development at Allianz.

In an international comparison, EMU as a whole fares relatively well with a debt ratio of 78.2 percent of gross domestic product (GDP). Japan’s debt ratio of around 190 percent is substantially higher and the USA, with 83.1 percent of GDP, also fares worse than the euro area.

Greece, along with other euro area countries with financial problems, must now present a convincing fiscal consolidation concept. Empirical studies and various country examples from the past show that a drastic consolidation drive can have a positive impact on growth. “A plausible consolidation program eliminates false incentives, buoys investment and private consumption and, in the medium term, can trigger a surge in growth,” said Heise.

Should Greece implement an austerity package which lowers the borrowing requirement in 2010 to the planned 8.7 percent of GDP, the Allianz economists expect GDP to fall by around 5%. The economic nosedive will start to slow as early as 2011/2012. The markets will honor the reduction in new borrowing and spreads on Greek government bonds will fall substantially. The level of debt is already likely to fall slightly in 2013. All told, this means that, even with a rigorous austerity drive, the situation of Greek public finances will remain very difficult for a longer spell, but the momentum of the rise in debt can be stopped soon. 

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