Are Euro zone debt levels sustainable?

Some sovereigns are still struggling to convince investors they will be refunded in due course. Taming deficit is widely branded as the only way out, no matter the prize it might involve in terms of growth gap. The steeply rising gross debt figure, reckoned to fly as high as 95% GDP for the Euro zone by the close of this year, sends shivers down the spine. The average is bad enough but a number of individual countries show a most appalling record. The fear they might fail, putting financial solidarity between partners under severe stress, fuels whenever a crisis emerges renewed doubts on the Euro as a common currency zone.

Recovering from the Cyprus imbroglio, now it faces a potential challenge in Portugal, for all the efforts its Government is performing to save from wreckage the austerity plan badly mauled by the Constitutional Court ruling. Once again the danger of utter discomfiture looks too familiar. And the recipe is likely to be the same: slashing spending in the midst of a marked recession to ensure a balanced budget in a short period of time.

Putting the blame on deficit appears as the mainstream policy to curb a disorderly debt expansion and the risk it might spin off out of control. Little attention is paid to other items that exert a decisive influence on mounting public liabilities. Since 2007 gross debt has grown by 4.7 % on a yearly average. Primary deficit, as such, accounts for only a quarter of it. The exchange rate impact of foreign currency debt issued plus some stock-flow adjustments represent more than 30%. But up to 45% is to be attributed to interest payments minus the non-stop wearing effect on debt value of nominal GDP, in other words real growth and inflation.

One would expect interests to stand as the main culprit. But the average paid by the Euro zone in 2008-2013 amounts to a smaller GDP percentage than in previous years. Nothing to do with a miracle, even if paying less when you owe more might be ranked as such. The merit goes to the marked lowering of rates responsible for a 20% rebate on the yearly bill. In contrast to such a positive trend, lack of growth has played a key role in debt snow-balling. In 2003-2007 it helped to diminish liabilities by 3.5% GDP on a yearly average. Over the last 6-year period this figure has crumbled by 2.5 percentage points, accounting for roughly half of the debt piling. Thus lack of growth bears a greater responsibility than public deficits.

Average reasoning too often hides huge divergent performances. The overwhelming weight of prosperous and fair performing countries in the Euro area conceals the desperate situation some partners face. Greece and Portugal have to cope with an interest bill than doubles that of Germany, while recession prevents them from wiping out debt as fast as they should. Undoubtedly they are bound to undertake an extra effort in curbing excessive deficit. But forcing them to sacrifice growth leads nowhere except to future tempests should their debt sustainability come under suspicion once again. A likely event if financial solidarity is administered in such small doses only when Euro survival is at stake.

About the Author

JP Marin Arrese
Juan Pedro Marín Arrese is a Madrid-based economic analyst and observer. He regularly publishes articles in the Spanish leading financial newspaper 'Expansión'.

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