France comes under fire in latest European Commission economic assessment

The European Commission has just released its latest round of country-specific recommendations (the Commission’s advice on how the country can boost economic growth and maintain stable public finances).

As with the broader economic state of the eurozone, the recommendations are a bit of a mixed bag. There are some positive assessments of the peripheral countries, but also warning over continuing problems with high debt levels and high unemployment.

We would argue that there is also still too much complacency on the former and not enough urgency on the latter points. Below, we've picked out some of the more interesting points for the big four countries.

FRANCE
The European Commission’s assessment of the French economy is quite damning, given the context of a supposed economic recovery. The Commission says that the “level of detail of the fiscal consolidation measures is insufficient” to ensure France meets its targets and that the economic forecasts used for 2015 are “slightly optimistic” and the planned savings are “very ambitious”.

The Commission also takes aim at areas of the economy which the Socialist government will not be too pleased with, specifically arguing that “sizeable short-term savings cannot be achieved without” curbing health and pension costs through reforms of both sectors. The report also hits out at French labour costs, warning that they reduce “firms’ profitability”, and its ranking in surveys of business environment which has “deteriorated” not least due to regulation which hampers growth of small business in France, the significant number of protected professions and the high overall tax burden.

Therefore, the European Commission calls for action on all these areas. Ultimately, the report does a decent job of highlighting the on-going flaws in the French economy and the lack of strategy displayed by the French government. While it has taken tentative steps towards reform in some areas others fly under the radar while the government does not yet seem to have fully bought into the reforms it has laid out for the coming years.

GERMANY
The recommendations for Germany feel very familiar with early comments regarding its current account surplus. Specifically the report calls on Germany to:

“Improve conditions that further support domestic demand, inter alia by reducing high taxes and social security contributions, especially for low-wage earners.”

However, there is not an extensive discussion and the report focuses on other areas which include some interesting recommendations such as “more ambitious measures to further stimulate competition in the services sector” (something we have long advocated) and “more efficient public investment in infrastructure, education and research”.

ITALY
The European Commission seems to have doubts over Italy’s latest budget forecasts labelling them "slightly optimistic.” “The achievement of the budgetary targets is not fully supported by sufficiently detailed measures, in particular as of 2015”, the Commission continues. This will certainly revive the domestic debate between Italian Prime Minister Matteo Renzi and his critics, who argue that there is not enough money to cover for the tax cuts for workers and businesses recently announced by the Italian government.

On labour market reform it notes, “Globally, the Italian labour market continues to be marked by segmentation and low participation…Therefore, the limited steps taken so far need to be extended.” Here, the recommendation is to “assess the need for additional action” by the end of the year. Another long-running issue in Italy is services liberalisation. According to the Commission, “There are still a number of bottlenecks to competition (reserved areas of activity, concession/authorisation schemes, etc.) in professional services, insurance, fuel distribution, retail and postal services” – and these need to be removed.

Interestingly, the European Commission also notes that “one of the key levers to improve the implementation performance [of Italy]…lies in enhanced coordination and a more efficient allocation of competences among the various levels of government”. This reform is already on Renzi’s radar. Still, we’re not sure how well this specific ‘suggestion’ will go down in Italy, given that it touches on a politically sensitive issue – the distribution of powers between the central government and the regions, which is laid out in the Italian constitution

SPAIN
The European Commission finds Spain’s budgetary forecasts “broadly plausible for 2014 and subject to downside risks in 2015”. However, “for 2016-2017, the GDP growth rate in the [Spanish government’s] programme seem somewhat optimistic.” Similar to Italy, the European Commission’s recommendation to Spain is to “reinforce the budgetary strategy as of 2014, in particular by fully specifying the underlying measures for the year 2015 and beyond.” 

Although the European Commission acknowledges that Spain’s labour market reforms have gone some way in ensuring greater flexibility, limiting job losses and reducing the number of dismissals challenged in court, “Segmentation remains an important challenge for the Spanish labour market, the number of contract types remain high and the gap between severance costs for fixed-term and indefinite contracts remains among the highest in the EU even after the reform.” Furthermore, “the inadequate labour-market relevance of education and training and the high proportion of unemployed without formal qualifications contribute to the high youth unemployment rate, as well as to long term unemployment.” Therefore, the European Commission recommends that the Spanish government “enhance the effectiveness and targeting of active labour market policies, including hiring subsidies” and “reinforce the coordination between labour market and education and training policies.”

Some variance from country to county but a couple of clear themes can be found here. Much more work needs to be done on labour market reform and improving the business climate. On top of this the forecasts continue to be optimistic. Plenty of work to be done on many fronts then. 

European Commission forecasts fragile recovery in the eurozone

The European Commission today released its autumn 2013 economic forecast. The EC broadly sees a

recovery in the eurozone, but does highlight that it remains fragile and that unemployment is expected to increase while further austerity also seems likely. The key figures have been widely covered so we won’t rehash them here. Below we pick out a few key points from some key countries which caught our eye.

CYPRUS
Not much new in what remains a dire forecast for Cyprus. In an otherwise sea of declining figures, net exports remains the one hope as a source of positive growth. Ultimately, any success in this area will be determined by the removal of capital controls. Until this is cleared up, significant uncertainty will remain.

FRANCE
France is facing low growth for this and next year (0.2% and 0.9% respectively). In the meantime, unemployment is going to increase slightly, as “the positive effects of the recent labour market reform are only expected to be visible from 2015.” Unsurprisingly, the Commission notes that most of the adjustment in France has so far come from tax hikes – and warns that “GDP growth significantly below potential and revenue shortfalls, which may be due to unusually low tax elasticity with respect to GDP, are having a negative impact on the nominal deficit.” Actually, the Commission already believes that, absent new measures, France will miss its deficit targets for 2014 and 2015.

GREECE
Despite a positive tone, the figures still make for difficult reading. The forecast recovery is reliant on jumps in exports and in particular tourism, something which is far from guaranteed particularly if the euro remains strong. Also, investment is expected to go from a 5.9% contraction in 2013 to 5.3% growth in 2014. Even from a low base, this looks like a heroic turnaround. Unemployment is also expected to begin dropping next year, over the course of the crisis forecasts on this front have proven misguided. The signs suggest it could still increase slightly or at least remain elevated.

IRELAND
Importantly, the adjustment in Ireland will become increasingly reliant on domestic consumption and investment, the outlook of which remains uncertain. Exports will continue to contribute but significantly less so than recently, while public spending will continue to be a drag on GDP.

ITALY
In line with the IMF, the Commission sees the Italian economy shrinking by a further 1.8% this year and then go back to limited growth next year. The Commission admits that its prediction “does not incorporate the benefits from the full implementation of the adopted structural reforms, as they could take more time to materialise.” Interestingly, the report seems to suggest that the potential benefits of “projected moderate wage growth” in terms of price competitiveness could be offset by the appreciation of the euro vis-à-vis other currencies. As regards Italy’s gigantic public debt, the Commission believes it will begin to fall only in 2015.

PORTUGAL
Again a familiar story, with a tentative turnaround off the back of increasing investment and exports. However, the Commission highlights an important downside risk from the interventions of the Portuguese Constitutional Court, which have already threatened to derail Portugal’s bailout programme. EU Economic and Monetary Affairs Commissioner Olli Rehn reiterated this point in his press conference.

SPAIN
Despite some positive signs, the Commission is quite clear that “still large adjustment needs will constrain the strength of the recovery” in Spain. Furthermore, “financing conditions for households and companies remain relatively tight, in particular for smaller borrowers.” Confirming our previous analysis (see here and here), the Commission notes that the recent decline in Spanish unemployment “was largely driven by a contraction of the labour force and some seasonal factors.” On the deficit side, the Commission has no good news for Spain. Without additional measures, the deficit is expected to increase to 6.6% of GDP in 2015. Remember, Spain has already been given two extra years to cut its deficit and bring it below 3% of GDP by 2016.  

SLOVENIA
Along with Cyprus, the only country forecast to contract next year. Reliant on exports to limit this contract as domestic demand, investment and public spending collapse. The key will be the upcoming bank recapitalisation which the Commission forecasts will cost 1.8% of GDP (as we have noted before, this cost could end up being higher). Whether the government can afford this without external help remains to be seen.

GERMANY
Unsurprisingly, Germany is in a better shape than its eurozone counterparts – with its economy projected to grow by 1.7% and 1.9% in 2014 and 2015 respectively and the unemployment rate expected to keep going down to 5.1% in two years’ time. According to the European Commission, “After a temporary deceleration in 2013, growth in wages and compensation per employee is set to reaccelerate, so Unit Labour Cost growth would remain above the euro area average” – which should help the rebalancing. Interestingly, the Commission’s own figures also show that Germany is breaching the threshold of 6% of GDP for current account surplus. Will Germany get some sort of official warning for this?

A few interesting points then, but as is often the case with these forecasts, they raise as many questions as they answer. Next week’s assessment of the macroeconomic imbalances may provide a bit more meat to the European Commission’s analysis and given the recent political uproar, its view of current accounts could make for interesting reading. In any case, it’s clear that the EC continues to see this as a very fragile recovery.

Spanish deficit: The saga continues

Keeping count of how many times Spain's deficit targets and forecasts have been revised has become a challenging exercise. Following the publication of its draft budget for 2013, the Spanish government has admitted that Spanish deficit at the end of this year will be as high as 7.4% of GDP - with the EU-mandated target fixed at 6.3% of GDP - once the potential losses on the government's recent cash injections in the banking sector are taken into account.

However, pending official confirmation from the EU's statistics body, Eurostat, it looks like aid to banks will not be counted in the Excessive Deficit Procedure (EDP) currently open against Spain. Speaking after his meeting with Spanish Prime Minister Mariano Rajoy yesterday, EU Economic and Monetary Affairs Commissioner Olli Rehn suggested,

It can be expected that this kind of element of increase in the fiscal deficit related to bank capitalisation will be treated as a one-off and will not affect the structural deficit.  

We would not be too sure that this settles the question, though. First of all, the EDP covers more than just the structural deficit while other one off impacts (such as Portugal's transfers from its pension funds) have counted towards reducing the deficit. Secondly, it will be interesting to see how Germany, Finland and others will react - given that, in practice, Spain has just said that it will fail to meet its deficit target again.

In the meantime, as we pointed out on this blog last week, the time for big decisions is approaching for Rajoy. The results of the stress tests have been published, and the draft budget for 2013 has been unveiled. In particular, both the European Commission and Spanish Economy Minister Luis de Guindos have stressed that the measures planned by Madrid for next year go "beyond" the recommendations Spain has been made under the new 'European Semester' - potentially paving the way for an EFSF/ECB bond-buying request without unexpected additional conditions attached to it.

Unsurprisingly, rumours of an imminent request have kicked off. According to a senior European source quoted by Reuters,

The Spanish were a bit hesitant but now they are ready to request aid.

With the next meeting of eurozone finance ministers taking place on Monday, this weekend looked perfect for Madrid to apply for an EFSF/ECB bond-buying programme. However, Rajoy reportedly told a meeting of regional Presidents from his party that he would not make the request this weekend. During a press conference less than an hour ago, he also replied with a curt 'No' to a journalist asking whether the request was "imminent."

The domestic political reasons for a delay in the decision (key regional elections in Basque Country, Galicia and Catalonia over the next two months, plus the obsession with avoiding humiliación) are well-known. Apparently, Germany is also standing in the way. Sources have suggested that the German government is keen to "bundle" Spain, Cyprus and Greece into a single dossier, rather than submitting individual aid requests to the Bundestag for approval.

Beggars cannot be choosers, and Rajoy cannot simply ignore Germany's reservations. Luckily for him, they could even turn out to be convenient on the domestic front. As in previous instances, though, the markets will likely play a big role in the timing of any bailout: a sharp surge in Spain's borrowing costs could certainly precipitate a request. Should this happen, Rajoy would find plenty of occasions to present a formal request for aid - the next one potentially being the EU summit on 18-19 October...  
 

Meanwhile, in Italy...

Italian daily La Repubblica had an interesting story over the weekend. Apparently, Italian Prime Minister Mario Monti and his team are trying to win support for watering down the EU's deficit and debt rules.

Italy is suggesting that 'virtuous investments' (i.e. public spending aimed at boosting 'growth') should not be counted when calculating a country's deficit and debt under the EU's budget rules (3% deficit, 60% debt-to-GDP ratio). The same exception should be applied to the re-payment of money currently owed by the various public administrations to private firms - some €70 billion in Italy's case.

The always well-informed Marco Zatterin - Brussels correspondent for La Stampa - writes on his blog that Italian Europe Minister Enzo Moavero Milanesi has already been talking to EU Commissioners for Internal Market (Michel Barnier), the Budget (Janusz Lewandowski), and Industry (Antonio Tajani, Italy's man in the Commission) over the past few days. EU Economics and Monetary Affairs Commissioner Olli Rehn is reportedly willing to consider the proposal. The Monti government hopes that EU leaders will discuss the proposal at the European Council at the end of June.

These exceptions, Italy's reasoning goes, would make the fiscal treaty "more sustainable" once it comes into effect. But is this really a good idea? As we pointed out before (see here and here), the fiscal treaty already has some serious credibility issues and has already been watered down.

Allowing for some debt to be swept under the carpet doesn't exactly inspire confidence. Do people remember how we got here in the first place?

Meanwhile, mayoral elections took place in Italy over the weekend (we understand if you didn't notice given everything else that was going on during the eurozone's 'Super Sunday'). Still, a couple of interesting facts are worth flagging up:

• Candidates from Silvio Berlusconi's People of Freedom party did not make it to the second round in any of the bigger cities where elections took place (Genoa, Palermo, Parma and others). Following the results, the party's Secretary General, Angelino Alfano, said that backing for Monti's government continues, but no more 'mini-summits' with the centre and centre-left leaders supporting Italy's technocratic cabinet in parliament will be held from now on. This could have an impact on Monti's ability to push through his reform agenda, especially since he has no electoral mandate to fall back on when things get tough;
 

• Lega Nord, Berlusconi's former ally, also did quite badly in the wake of the scandals that forced its leader Umberto Bossi to step down last month. Lega Nord managed to keep Verona, but lost several towns traditionally considered strongholds in the Lombardy region;
 

• Turnout was about 67% - almost 7% lower than in the previous local elections;

• The Movimento Cinque Stelle (Five Star Movement), led by Italian stand-up comedian Beppe Grillo (in the picture) came out as the real winner. Its candidates achieved double-digit percentages in a couple of important cities (including Genoa, Beppe Grillo's home town, and Parma, where the Five Star Movement's candidate Federico Pizzarotti made it to the final run-off, with 19.5% of votes). A political maverick, Grillo has been campaigning for the need to clean up Italian politics, for instance by barring convicted people from running for the Italian parliament. Most interestingly, he has recently been claiming that Italy should drop the euro (but remain in the EU) and refuse to pay back at least part of its public debt. 

The general elections will be a different ballgame altogether, but it's interesting how the Italians, too, are now looking for something different.

The Commission takes transparency too far...

In a light-hearted break from the doom and gloom of the eurozone crisis, Italian daily Il Corriere della Sera reports that yesterday EU Economic and Monetary Affairs Commissioner Olli Rehn had to field a couple of particularly tough questions during his regular midday press briefing.

Were they about the future of Greece? Or the lack of growth in the eurozone? No.

Apparently, earlier this week the Finnish Commissioner held a very confidential meeting with six male reporters from several major European dailies...in the European Commission's sauna! Yes, it has a sauna.

The briefing was supposed to remain secret, but it soon became common knowledge in the crowded press room. A German journalist asked Rehn whether he was planning to extend such "confidential briefings" to female reporters at some point. Clearly embarrassed, Rehn managed to put together an answer,

I've regular contacts with journalists, in various contexts, on and off the record. I take note that there's an interest with regard to these meetings.

Ivo Caizzi, Brussels correspondent for Il Corriere della Sera, went one further, enquiring about the dress code for such meetings. Olli Rehn, his head bent, was left speechless, while his Spanish spokesman promptly said that there was no need to provide further details (not that anyone was desperate to know them!) because everyone is aware of "Finnish customs" when it comes to the use of saunas.

Some things are best kept under wraps Olli...

'We've only held up a mirror'

The Slovakian Parliament has overturned the decision by the country's previous government to help fund the €110bn eurozone bailout of Greece. Slovak MPs voted by 69 to two to refuse to take part. Slovak Finance Minister Ivan Miklos trashed the logic behind the bailout, telling the Slovak Parliament:

I do not consider it solidarity if it is solidarity between the poor and the rich, of the responsible with the irresponsible, or of taxpayers with bank owners and managers.

The European Commission, being the non-political organisation that never meddles in national politics that it is, rushed to condemn the move. EU Economic Affairs Commissioner Olli Rehn yesterday said,

I can only regret this breach of solidarity within the euro area and I expect the eurogroup and the [economic and finance ministers'] Council to return to the matter in their next meeting.

And in what can only be considered a thinly veiled threat, Mr. Rehn's spokesman added that Slovakia will not face any legal penalty for its Greek u-turn but should expect unspecified "political consequences."

But Mr. Miklos had a thing or two to say himself,

It's true the top politicians in the eurozone are not excited by our position and that we have irritated them quite a lot. But this is only because they have been creating alibis for themselves and we have held up their behaviour to a mirror.

Bulls-eye!

NB: At the same time, Slovak MPs did back the country's participation in the eurozone's overarching €750 billion bailout fund, the European Financial Stability Facility (EFSF), which puts Slovak taxpayers on the hook for €4.4 billion.