Comment: Austerity begets austerity, the wrong script

The eurozone crisis response continues to follow the same old script of trading austerity for bailout funds.

Given the severity of the economic contraction suffered by Greece during the past few years one would have thought that a modest shift from the usual script would have seen an emphasis on growth as opposed to growth through austerity.

The crisis focus takes the view that in order to solve it, all that is needed is for peripheral countries to undertake fiscal austerity – and all that is needed to prevent a future crisis is for measures to be in place to prevent fiscal profligacy (the fiscal compact).

When S&P carried out its multiple downgrades on January 13 they highlighted how the current problems are as much to do with fiscal policy as they are to do with “rising external imbalances and divergences in competitiveness”. We have highlighted how peripheral countries face a net savings shortfall which makes itself felt in a c/a deficit position which was easy to finance in risk-on years but less so now that these countries are seen as risky.

Recognition of this imbalances/competitiveness aspect would see other pro-growth/investment policies in addition to fiscal austerity being prescribed for peripheral countries. As long as we walk down a fiscal austerity road it is going to be difficult to put the crisis to rest even if we see a move toward the ECB actively utilising its balance sheet via QE. Greece will need to come back to the table for another bailout and with PSI limit reached and OSI involving the ECB the default risks will be greater next time.

We continue to see the risks tilted toward a higher peripheral yields, wider spreads and flatter curves but for now it’s better to stay neutral and look for the three-year LTRO to pass before looking for a correction.

The elections in France look to be much more significant an event as Germany seems to be uncomfortable working alongside any other President than Sarkozy.