From strict EU fiscal rules to growth-supportive policies despite high public debt ratios

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1 From strict EU fiscal rules to growth-supportive policies despite high public debt ratios Pernille Bomholdt Henneberg Senior Analyst / August 2016 Investment Research Important disclosures and certifications are contained from page 10 of this report. 1

2 Growth-supportive fiscal policies despite high public debt Focus is now on counter-cyclical fiscal policy Euro area public debt and deficit ratios are set to continue to decline in but the European Commission expects debt ratios to be below 60% in only five (smaller) of the 19 euro area countries in 2016 (see pages 3-4). Public debt and deficit ratios continue lower The high government debt, particularly in the periphery countries, no longer rules out fiscal policy easing as EU member states and authorities are now paying more attention to counter-cyclical fiscal policy than fiscal sustainability considerations. Based on this, we believe fiscal policy easing is likely to play a bigger role going forward, which should be welcomed under the current climate of central bank fatigue. Source: Eurostat, Danske Bank Markets (forecasts) 2

3 High public debt no longer limits the room for fiscal easing 14 EA countries with public debt above 60% Public deficit above 3% in several countries Source: Eurostat (2015 values), Danske Bank Markets Source: Eurostat (2015 values), Danske Bank Markets 3

4 EU Commission recommends cancelling fines for Spain + Portugal EU fiscal rules are no longer strictly followed Last week, the European Commission recommended cancelling the fines for Spain and Portugal despite their lack of effective action to correct excessive deficits (see press release). Fiscal stance and public debt not correlated Ahead of this, the EU Council had already demonstrated some flexibility in the EU fiscal rules by extending the deadline for correcting the excessive deficit for several countries including France and The Netherlands. The European Commission concluded in its latest economic forecasts the projected fiscal effort is not always related to the level of the debt-to-gdp ratio at the country level ; hence, a country with high public debt should also be able to ease fiscal policy (see Spring 2016 Forecast). Source: European Commission (forecasts), Danske Bank Markets 4

5 Significant fiscal headwind is becoming a small tailwind From large fiscal headwind to small tailwind Small fiscal tailwind in both 2016 and 2017 The fiscal stance in the euro area is set to be growth supportive again in following a period when the euro area was faced with a significant fiscal headwind. The expected fiscal policy easing measures in 2016 include tax cuts and additional government expenditure related to the inflow of asylum seekers in some countries. Across countries, the European Commission projects the fiscal stance to remain counter-cyclical in the majority of countries. Among countries with a projected negative output gap in 2016, an expansionary fiscal policy is expected in 11 countries, while a fiscal tightening is expected in the remaining two (see page 6). Source: European Commission (forecasts), Danske Bank Markets 5

6 Counter-cyclical fiscal stance in the majority of countries Fiscal policy support under large output gap Weak growth is supported by fiscal stance Source: European Commission (forecasts), Danske Bank Markets Source: European Commission (forecasts), Danske Bank Markets 6

7 Could an economic downturn result in significant fiscal easing? Considerable easing depends on Germany Following the UK s decision to leave the EU, the risk of an economic recession in the euro area has increased, which could spark the need for fiscal policy easing not least in light of the overloaded monetary policy. A significant fiscal easing in the euro area depends to a large degree on Germany, as (1) it amounts to 29% of the euro area economy and (2) it is one of the countries with the largest fiscal room, which is not eventually bound to bring down an unsustainable debt. However, from a cyclical point of view, the need for German fiscal easing is modest as reflected in the unemployment rate being below its structural level (see also the output gap and GDP growth charts on page 6). Large German economy with fiscal room Share of euro area GDP, 2015 Public deficit-to-gdp Fiscal room, 2015 Public debt-to-gdp Germany 29.1% 0.7% 71% -0.5% France 21.0% -3.5% 96% -0.1% Italy 15.7% -2.6% 133% -0.7% Spain 10.4% -5.1% 99% -0.2% Netherlands 6.5% -1.8% 65% -0.3% Belgium 3.9% -2.6% 106% -0.4% Austria 3.3% -1.2% 86% -0.5% Ireland 2.5% -2.3% 94% 0.8% Finland 2.0% -2.7% 63% -0.2% Portugal 1.7% -4.4% 129% 1.0% Greece 1.7% -7.2% 177% 3.6% Slovakia 0.8% -3.0% 53% 0.1% Luxembourg 0.5% 1.2% 21% -0.3% Slovenia 0.4% -2.9% 83% 0.0% Lithuania 0.4% -0.2% 43% -1.1% Latvia 0.2% -1.3% 36% 0.0% Estonia 0.2% 0.4% 10% -0.4% Cyprus 0.2% -1.0% 109% -0.8% Malta 0.1% -1.5% 64% 0.4% *Change in cyclically adjusted primary balance (positive figure = tightening, negative figure = easing) Source: European Commission (forecasts), Danske Bank Markets Expected fiscal stance, 2016* 7

8 German population wants to stimulate investments German fiscal policy could be used more The opinion among German politicians seems to be that due to the cyclical situation the need to ease fiscal policy is limited, especially in the current situation where the monetary policy is considered loose. However, the public German opinion is different, as 70% agree that public money should be used to stimulate private sector investment at the EU level. This suggests that German fiscal policy could be used to a larger extent going forward. Nevertheless, we do not believe in a considerable fiscal easing in Germany because of the fear of overheating the economy. Germans want to stimulate EU investments Public money should be used to stimulate private sector investment at EU level Cyprus Malta Germany Slovenia Belgium Latvia Greece Luxembourg Ireland Lithuania Finland Italy Austria Estonia Slovakia Portugal France Netherlands Spain 0% 20% 40% 60% 80% 100% Agree Disagree Don't know Source: European Commission Eurobarometer, Danske Bank Markets 8

9 Conclusion High government debt no longer rules out fiscal policy easing, as EU member states and authorities are now paying more attention to counter-cyclical fiscal policy than fiscal sustainability considerations. However, despite room for further fiscal easing in some countries, we still doubt we will see a larger fiscal policy response in a scenario of a severe recessionary shock. Currently, the countries with the largest fiscal room are those that do not need the easing. We believe fiscal policy easing is likely to play a bigger role going forward, which should be welcomed under the current climate of central bank fatigue. A significant fiscal easing in the euro area depends largely on Germany, as it is the largest euro area economy and as it is one of the countries that is not eventually bound to bring down an unsustainable debt. German politicians seem less willing to ease fiscal policy due to the cyclical situation but the public is in favour of spending public money on stimulating private sector investment at the EU level. This suggests that German fiscal policy could be used to a larger extent going forward. Nevertheless, we do not believe in a considerable fiscal easing in Germany because of the current fear of overheating the economy. See also our presentation Unchanged support for the euro before Brexit, but optimism about EU s future is lower, 1 August. 9

10 Disclosures This research report has been prepared by Danske Research, a division of Danske Bank A/S ( Danske Bank ). The author of this research report Pernille Bomholdt Henneberg, Senior Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in this research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high-quality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Danske Bank is a market maker and may hold positions in the financial instruments mentioned in this research report. Danske Bank, its affiliates and subsidiaries are engaged in commercial banking, securities underwriting, dealing, trading, brokerage, investment management, investment banking, custody and other financial services activities, may be a lender to the companies mentioned in this publication and have whatever rights are available to a creditor under applicable law and the applicable loan and credit agreements. At any time, Danske Bank, its affiliates and subsidiaries may have credit or other information regarding the companies mentioned in this publication that is not available to or may not be used by the personnel responsible for the preparation of this report, which might affect the analysis and opinions expressed in this research report. See www-2.danskebank.com/link/researchdisclaimer for further disclosures and information. 10

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