European voter revolt bodes ill for India

The future of the Eurozone (comprising 17 European countries using the euro as their currency) is in doubt after voters in Greece and France threw out incumbents struggling to save the euro through supposed austerity measures. Socialist leader Francois Hollande won in France by promising economic growth, not austerity.

In Greece, the top two parties backing austerity to keep Greece within the Eurozone won less than half the seats in Parliament. The radical-left Syriza party—wanting to renege on Greek debts and abandon the euro—came second. A pro-austerity coalition might just be formed on the basis of asking lenders to ease conditions. This strategy looks implausible. Many analysts fear an impasse, leading to another Greek election in June. Opinion polls suggest that Syriza and other naysayers will come out on top.

The chances of a messy Greek exit from the Eurozone have shot up. If this happens, capital flight from other weak members (Portugal, Spain, Ireland, Italy) will follow. Their government bonds will plummet and their borrowing costs will rise correspondingly, threatening to take them down the Greek road. French bonds will tank if Hollande insists on defying austerity.

European banks have massive government bond holdings that could crash in value, causing a financial crisis. This will not be anywhere near as bad as the 2008 crisis, but could certainly be as bad as the financial freeze that hit Europe in late 2011, with contagion spreading to all emerging markets, including India.

If so, India’s currency and stock markets will plummet. The world will probably avoid a second Great Recession—the US and Asia will continue to be engines of global growth. But Europe’s GDP is bigger than that of the US, so global growth will slow greatly. European troubles could send shockwaves round the globe, inducing investors to pull out of all emerging markets and rush for the safe haven of the US dollar. This will hit India, which badly needs global financing to bridge its record current account deficit of 4% of GDP.

Optimists say “don’t panic.” They predict Hollande will become a realist after winning. Faced with a financial crisis last year, Eurozone leaders agreed on a tough fiscal compact to bring their finances in order, and thus quell fears of global creditors. This worked: creditors became convinced that fiscal austerity would keep Europe solvent, and this brought down interest rates on European bonds to manageable levels.

Alas, this respite is now in jeopardy. Voters in many countries are rebelling against austerity after four years of very slow and mostly jobless recovery from the 2008 Great Recession. Enough, they say, we now want growth.

Fast growth would indeed be lovely, but how can it be attained? Most European countries have deep structural problems —unsustainably high welfare spending, high fiscal deficits and a huge overhang of past debt. Four years of record fiscal deficits from 2008 onwards have produced only huge debts, not fast growth. Bigger deficits don’t look like the solution. Data show little real austerity in Europe, nothing like the austerity imposed by the IMF on Third World countries.

France’s fiscal deficit in 2011 was 5.8%, almost double the Maastricht Treaty’s limit of 3%. French public spending rose from 51.6% of GDP in 2000 to 56.8% in 2009, and declined only marginally to 55.9% in 2011. France has the highest government spending ratio in Europe, beating previous champions like Sweden. So, its supposed austerity today is mostly lip service. To prune pension benefits, it will raise its minimum retirement age from 60 to 62, but only by 2017! If voters cannot stomach even this much belt-tightening, lenders have reason to fear that France too might take the Greek road.

France lost its AAA credit rating last year. This rating will plummet further if Hollande reneges on the European fiscal compact. However, optimists expect Hollande to engineer a face-saving compromise with Germany.

Optimists hope Greece too will draw back from the brink. If it reneges on its debts and exits the Eurozone, it will be unable to pay salaries, will suffer huge inflation, and lack foreign exchange for essential imports.

Having vented their anger in last week’s election, will Greek voters now backtrack? Optimists predict that in a possible June election, voters will bring back the two big parties who insist austerity is essential to stay in the Eurozone.

Maybe. Again, maybe the European Central Bank will abandon its anti-inflation mandate and print trillions of euros to kickstart European growth. Maybe Germany will agree to rescue weaker members endlessly through devices like jointly guaranteed Eurobonds. And maybe pigs will fly.

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top