World Economy

Another Euro Crisis Looms

Italy could set the stage for the bloc’s next crisis if it delivers on its tax-cutting and high-spending policies.Italy could set the stage for the bloc’s next crisis if it delivers on its tax-cutting and high-spending policies.

Capital investment in 24 of the EU’s 28 member states has fallen dramatically over the past ten years, according to data from the statistical agency Eurostat.

Investment decreased on average by 2.3%, falling to 20.1% of GDP last year. It stood at 22.4% from 2007 to 2017 period. Countries in Europe’s east and south, which were more vulnerable to the crisis, experienced the biggest drops in investment in the years following the crisis, according to Eurostat reports, LiveTradingNews reported.

Statistics showed that only three EU countries have seen their investments increase. Those are Sweden (from 23.9% of GDP in 2007 to 24.9%), Austria by 0.6% and Germany by 0.2%.

Last year, all EU countries invested around €3 billion ($3.5 billion) in public and private investments. The construction industry accounted for nearly half of investments, while machinery, equipment and weapons systems accounted for 31%. Investments into intellectual property products were 19%.

The EU’s investment fund (the European Fund for Strategic Investments), which was set up in the aftermath of the financial crisis to address the investment deficit, has mobilized €284 billion ($335 billion) to date. It plans to raise €500 billion by 2020.

According to the European Investment Bank’s website “it aims to mobilize private investments in projects which are strategically important for the EU.”

Rainy Day Fund

The head of the International Monetary Fund Christine Lagarde has announced plans to create a ‘rainy day fund’ for the eurozone to provide a buffer against economic downturns for the single currency union.

The IMF boss urged Europe towards more integration, including on spending. Lagarde hailed a “sustained and broadly shared upswing” in the global economy. “But there are other, forceful headwinds threatening. Think of the rise of populism and the short-sighted siren call of protectionism,” Lagarde said in a speech in Berlin.

“A more unified eurozone can be a compass to prosperity for the region and a beacon of hope to the world,” the IMF managing director added.

According to Lagarde, to be ready for the next economic plunge, the eurozone nations should create a modernized capital markets union and a better banking union, as well as stepping into greater fiscal integration. Lagarde added that such a fiscal tool would reassure investors.

The proposed ‘rainy day fund’ is expected to receive annual contributions from eurozone countries to generate assets in good times. Then, in the event of a downturn, the nations could get transfers wherein states borrow from the fund in extreme circumstances and pay those loans back with future contributions.

Lagarde recommended that payoffs from the fund should be conditional on members sticking to EU fiscal rules. The nations would be expected to pay a premium in good times based on the benefits they receive in bad times.

Fears Over Italian Policies

Italy’s emerging ruling coalition is likely to put deeper eurozone integration on hold and could set the stage for the bloc’s next crisis if it delivers on its tax-cutting and high-spending policies, European policymakers and economists fear.

Italy’s anti-establishment 5-Star Movement and the far-right League's coalition deal would bring together two parties which both want to challenge European Union limits on government borrowing and spending.

EU rules limit government budget deficits to 3% of gross domestic product and debt to 60% of GDP and oblige governments to seek balanced budgets.

With debt of around 132% of GDP and slow economic growth, Italy has long been a worry for eurozone policymakers.

“With the M5S/LN government, the underlying problems of the Italian economy, including low growth, inflexible labor markets, inefficient banking system and public administration will not be tackled, in many cases only worsened,” Nordea Chief Strategist Jan von Gerich said in a note to clients.

 “In short, trust towards Italy is bound to face heavy tests under a M5S/LN government, even if the two parties will not be able to implement their program in full,” he said.

The new government still has plans for tax and spending that pose a challenge to the way the eurozone has been run hitherto. These involve a new citizens’ income, more generous pensions and lower taxes. Estimates suggest these measures will cost around €60 billion a year—some 3.5% of Italy’s GDP.

This would drive a coach and horses through the eurozone’s fiscal rules, which impose strict limits on the size of a budget deficit is allowed to run. It would also send Italy’s debt ratio—the size of the country’s public debt in relation to the size of its economy—up from just over 130% of GDP to around 150% of GDP.

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