Suparna Goswami Bhattacharya

February 2, 2016: Europe had been in the news in 2015, not every time for the right reasons though. Grexit, the Volkswagen scandal, migration crisis, Paris attacks were some of the low points which made economists and investors wonder whether or not to pin their hopes on this continent for 2016.

Though shakiness in the world economy, oil price slump, China’s slow growth did contribute to the sombre mood, not much improvement in the scenario is expected.

Angela Bouzanis, senior economist at FocusEconomics, believes that Europe’s recovery will continue in 2016. “We see Eurozone economy expanding 1.6%, slightly above what we predicted in 2015 (1.5%), amid solid domestic demand and continuation of an accommodative monetary policy,” she says.

Dan Kemp, Chief Investment Officer, EMEA, Morningstar, an investment research and management firm, says that while looking at Europe one needs to separate economic outlook from that of capital markets. “In economic terms, there is clear strength in business and consumer survey data and increased support from domestic demand. These indicate underlying trends remain robust,” says Kemp. However, in capital market terms, much of the good economic news appears to have been already priced into European equities and, consequently, most equity markets look expensive. “The risks appear to be on downside. Opportunities stem mainly from the structure of their capital markets, like their exposure to energy companies,” he said.

Though energy companies have been a drag on returns, the fact is that they are now materially underpriced and, therefore, represent an attractive long-term investment opportunity. “As we create our expected returns at a country and regional level from the bottom up, the value we perceive in these stocks is having a positive impact on our expected returns for those countries with significant exposure to energy companies,” he says.

However, a number of challenges remain, namely the political landscape, persistent high unemployment and very low inflation expectations. In addition, while a weak euro is conducive to export growth, external conditions are not. The emerging market slowdown, particularly in China, and overall pattern of slowing global trade will weigh on growth prospects this year.

Satyajit Das, a former banker and author of Age of Stagnation (published as A Banquet of Consequences in UK, Europe, Australia and NZ), says, “One has to understand that Europe’s tentative recovery was driven by negative short term rates, massive QE, a weaker euro (driven in part by these policies) and low oil prices. But the continent has a deteriorating outlook.”

For instance, German exports to emerging markets are slowing. Exports in August 2015 for Germany were 5.2 per cent lower than July, the sharpest monthly fall since the financial crisis, according to the national statistics office. Germany, which happens to be Europe’s biggest exporter, sends 6.5% of its exports to China, which has been experiencing a slowdown.

“Additionally, the Volkswagen emissions scandal has brought into question much vaunted European technical prowess. European debt problems remain unresolved. In the aftermath of the attacks in Paris, the French government has announced that they will not abide by deficit and debt limits. Italy refuses to bring public finances under control, despite a worsening debt-to-GDP ratio,” says Das.

As far as Greece is concerned, it is likely to be in spotlight this year as well. “Our panel sees Greece’s economy worsening this year, as tough economic reforms and austerity measures are expected to dampen private consumption and stifle the recovery. High unemployment, tax increases and pension reductions will likely push the economy to a 0.7% fall this year,” says Bouzanis

To be honest, Greece’s situation remains in flux. While the current government has been largely compliant with last summer’s bailout agreement, a number of key and controversial reforms still need to be passed. “The government holds a slim three-seat majority and political stability (or willingness to comply with creditor demands) is far from guaranteed. In addition, in the long-run, there is a large risk that this bailout could suffer from the same obstacles as its predecessor: foot-dragging on reforms, poorer than expected economic growth or political upheavals and the question of request of debt relief is yet to be answered,” adds Bouzanis.

Das echoes these views. “The government will find it difficult to meet bailout conditions raising the issue of default, Grexit or both, amidst growing reluctance for further support,” he says.

Greece apart, Portugal too has nothing positive to offer. Its new government, an uneasy coalition of foes, has sworn allegiance to the EU and the euro but is seeking major concessions. “With the highest total debt-to-GDP in the EU, a Portuguese debt restructuring, explicit or de facto, is not unimaginable,” Das says.

Despite positive talks, Spain’s public finances remain poor and unemployment unsustainably high. The recovery remains uneven with excessive reliance on domestic consumption and exports, primarily automobiles, to other European countries. With no clear winner emerging in the 2015 election, Spain remains vulnerable to political instability.

Adding to all these woes is Europe’s refugee crisis. “The current refugee situation in Europe is incredibly complex.  However, it is worth noting that the productive capacity of Europe has increased through the influx of a large number of additional workers,” says Kemp. The key challenge faced by governments is how to quickly integrate these new arrivals and manage the additional strain on the social infrastructure of the countries they settle in.

Das says that though Europe’s refugee crisis may boost economic activity but it is expensive, at around €10,000 per refugee per year initially, putting pressure on weak finances. “It has also highlighted deep divisions within the EU. Serious opposition to immigration and free movement of people required by the Schengen treaty has emerged.”

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Carsten Brzeski

July 14, 2015: After another marathon in Brussels, Eurozone leaders decided on a path towards a third bailout package for Greece. We are still waiting for the official and written summit declaration to be released but here is our first take on the deal, based on having listened to the press conferences of Tusk, Juncker and Dijsselbloem as well as the ones of Merkel, Hollande and Tsipras.

In short, the Greek government will now have to do almost everything the Greek people refused in last week’s referendum. As already reported earlier, Eurozone creditors have come up with several demands before agreeing to a third bailout package. This compromise can be divided into three categories: i) rebuilding trust; ii) negotiations on a third bailout package; and iii) how to deal with Greek debt.

As regards rebuilding trust, the Eurozone wanted Greece to pass several reforms through parliament by Wednesday, among these reforms were apparently the VAT and pension reforms but also improvements of the Greek statistical agency. Once the Greek government has agreed to the reforms, several Eurozone parliaments would decide on whether or not the official negotiations could be started. Only then, the negotiations between the three institutions (IMF, ECB, European Commission) on behalf of the ESM would start.

Judging from earlier reports, these negotiations will not be easy as the Eurozone creditors have asked the Greek government to come up with new and more concrete proposals on how to compensate for the earlier withdrawn reforms to the economy and the public sector. If and when these negotiations would come to a successful end, Greece would get a bailout of around €85bn. Already in the coming two months, Greece would need €7bn until next week Monday (remember the bond held by the ECB), another €5bn until mid-August and up to €25bn (of which €10bn should be immediately) for the Greek banks.

A prominent part of the potential deal, at least judging from the press conferences, is a privatisation trust fund. This fund, based in Greece, should guarantee fresh money of €50bn, of which €12.5bn should be used for domestic investment. The rest of the money would be for debt repayments.

Furthermore, the Troika is back. As stressed by Ms Merkel, the three institutions, formerly known as the Troika, will do the negotiations and would also be responsible for future surveillance and monitoring of progress. As Ms. Merkel said a third bailout package for Greece would not differ from earlier programmes or programmes for other Eurozone countries.

Finally, the Eurozone returned the idea of some debt restructuring – not forgiveness – as part of a third bailout. The 2012 agreement of the Eurogroup was taken as a point of reference for some kind of debt relief. However, Ms. Merkel stressed that a haircut on debt was not an option but that debt relief could come in the form of longer maturities and/or grace period. Interestingly, she said that this form of debt relief could come earlier than anticipated in the 2012 statement.

As regards the next steps, the Greek parliament now will have to pass the required reforms, then national Eurozone parliaments will have to give the green light to start the negotiations. Next week, the negotiations on a third package could start. In the meantime, the Eurogroup will look into options for bridge financing.

While all leaders tried to give the deal a positive spin, doubts and concerns in our view outweigh optimism and euphoria. It starts with the fact that there actually is no deal, yet. The “deal” is an agreement to start negotiations once certain conditions are met. It’s a declaration of intent. Moreover, there is little in the deal that could give the Greek economy a short-term boost. Neither the €12.5bn from a still to be built trust fund nor the promised €35bn investment from the Juncker plan are tangible enough to provide results. Furthermore, even if Greek parliament would pass the required reforms, it is unclear whether Tsipras could politically survive the negotiations. In fact, this looks like a deal he had been fighting against for a long while.

All of this means that the champagne bottles should still remain in the fridge for a while. Eurozone politicians should rather be prepared for additional long meetings and negotiations. Monday morning’s agreement was a typical European fudge, made possible by the fact that the Greek people are currently still overwhelmingly in favour of Eurozone membership and the Eurozone’s willingness to avoid Grexit. This is not the most stable fundament for sustainable calm. To the contrary, the Grexit might have been avoided for a couple of weeks or – in a best-case scenario – for a couple of months, but, as in any good horror movie, the ghosts will always return.

Carsten Brzeski is an analyst with ING

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