Pandemic threatens Eurozone’s existence

Submitted by InfoBrics, authored by Lucas Leiroz, research fellow in international law at the Federal University of Rio de Janeiro…

The economic impacts of the global pandemic of the new coronavirus are terrible worldwide. The expectation of global economic growth fell by at least 0.5% compared to last year. On all continents, nations are trying to balance their economies amid efforts to fight infection. One of the victims of this economic catastrophe may be the eurozone, which suffers serious risks from the current global crisis.

The fiscal response to the new coronavirus in Europe has been remarkable in most states, with strong investment to fight the infection and save the private sector. If, on the one hand, these measures are extremely necessary to save thousands of lives, on the other hand, the economic debt that they are causing in several countries is undeniable, which can have negative consequences in the long run.

In the most recent publication of the European Central Bank’s Financial Stability Review (May 2020), the hypothesis that some countries are unable to pay the debts they are taking to combat the virus was studied. In this scenario, it is speculated that some States choose to withdraw from the Eurozone, which would be tragic for the current project of economic and political integration on the European continent, shaking the very existence of the single European currency.

In the European Central Bank’s report, it is written that: “Fiscal policies that increase the supply of bonds issued by highly rated European entities relative to that of individual sovereigns will arguably reduce overall sovereign funding costs and, in some jurisdictions, decrease sovereign spreads via reduced fiscal debt levels, other things being equal. Should measures taken at the national or European level be deemed insufficient to preserve debt sustainability, the market assessment of redenomination risk might rise further”. “Redenomination risk” refers exactly to the danger that some countries will let the euro or the single currency collapse.

According to an ECB study, public debt in the Eurozone will grow by between 7% and 22% in 2020. The growth is due precisely to the fact that governments lend hundreds of billions of euros to try to save their economies. As a result of the increase in the loan index, the debt-to-GDP ratio was raised from 86% to 103% across the European continent, putting the bloc’s economy at serious risk.

Generally, the goal of European countries is to keep the public debt below 60%. Obviously, this limit was lifted during the pandemic, due to the need to increase general CATS. The Bank reported that CATS are being well cared for and that they have helped to save many lives and declared support for future economic recovery initiatives.

“The pandemic caused one of the most severe economic contractions in recent history, but comprehensive policy measures have prevented a financial meltdown. (…) However, the repercussions of the pandemic on the prospects of bank profitability and on medium-term public finances will need to be addressed so that our financial system can continue to support the economic recovery “, stated the ECB vice president, Luis de Guindos, who also pointed out that the differences between government debt yields could widen if investors assess that public debt sustainability has deteriorated.

“A more severe and prolonged economic contraction than envisaged, if coupled with higher sovereign funding costs for some euro area countries and the materialization of contingent liabilities, would risk putting the public debt-to-GDP ratio on an unsustainable path in already highly indebted countries”, said the ECB.

According to the ECB, bank valuations across the European region have fallen to minimum levels, while financing costs have increased significantly. Finally, the return on equity of eurozone banks in 2020 is expected to be “significantly less” than it was before the pandemic. The ECB’s banking supervisory authority recommended that banks temporarily refrain from “paying dividends or repurchasing shares, strengthening their ability to absorb losses and avoid deleveraging”. These capital measures are expected to remain in effect until the economic recovery is “well established”, completed the ECB report.

The relative success of the European Union in promoting the first steps towards the integration of Europe is noteworthy. However, the decline of the European system is also undoubted. Recent events, such as the Brexit, have demonstrated the willingness of many political groups to leave the European bloc. The pandemic will certainly be a great opportunity for groups interested in this discourse, generating the growth of national projects parallel to Europe, in addition to a critical point of view in relation to the European Union even in countries that eventually remain in the bloc and in the eurozone.

It is practically inevitable that some countries will leave the eurozone; and even if only a few States do so, that would be enough to shake the structures of the integration project. In the long run, it is possible that the euro will definitely be buried in the post-pandemic world.