New Dawn for Peripheral Europe?
Darren Williams (pictured) and Dennis Shen
When Mario Draghi pledged to do “whatever it takes” to save the euro in July 2012, nobody expected things to change so quickly. Peripheral bond markets have since turned around sharply, supporting the European economic recovery. But can the improvements be sustained after countries exit their bailouts?
The commitment by European Central Bank President Draghi was a decisive moment in the crisis. Less than two years later, borrowing costs for bailed-out countries have tumbled back to pre-crisis levels and, in many cases, stand near all-time lows (Display). Current favorable market conditions have prompted Ireland, Portugal and Greece to take steps to exit their bailout programs and the associated harsh conditionality. This return to private financing marks an important transition from the worst of the crisis.
Ireland Leads the Way
The story started last December, when Ireland left its three-year bailout from the European Union (EU) and International Monetary Fund (IMF) without additional support and/or intervention. In our view, Ireland’s “clean exit” was justified by its large cash balance, low financing rates, manageable near-term funding needs and improvements in its economy.
Next up is Portugal. In the last five months, Portugal has knocked about €15.5 billion from its near-term funding needs in its return to international bond markets, culminating in last month’s resumption of regular bond auctions. On Sunday, Portugal announced it will make a clean exit when its bailout expires on May 17. Portugal probably isn’t as prepared to go it alone as Ireland was. Still, the recent sharp improvements in its circumstances make a successful clean exit more likely than we thought just a few months ago.
Can Greece Exit?
That leaves Greece. The country’s policymakers are visibly opposed to a third bailout from the EU when the current second bailout facility expires at the end of 2014. However, Greece’s ability to go without additional loans depends on whether it can raise a limited amount—estimated by the IMF at €11 billion for 2014 and 2015—from private sources.
Until very recently, a Greek bailout exit in late 2014 appeared unthinkable. However, rapid improvements in market conditions and this month’s successful bond auction—just two years after the largest default in sovereign history—make it more likely now that Greece will be able to meet its limited near-term financing needs via private sources. This increases the chances of a bailout exit later this year, in our view. However, it would not solve Greece’s many fundamental problems and any reduction in external pressure could reduce momentum for critical reforms.
In our view, the jury is still out for countries that exit the bailouts. Despite meaningful progress, peripheral European economies still face many tough challenges. Structural adjustments are not complete and policymakers must ensure that they sustain an early recovery and combat high unemployment.
Moreover, debt ratios are still at peak levels—Greece’s public debt stands at 175% of GDP, Portugal at 129% and Ireland at 124%. Against this backdrop, continued fiscal restraint and efforts to boost nominal growth rates will be required to address longer-term debt sustainability.
Investors must pay close attention to how these challenges are going to be met as the bailout exodus gathers momentum.
Darren Williams is Senior European Economist and Dennis Shen is Economic Associate, both at AllianceBernstein.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.