Europe Markets

EIU warns of no recovery until 2022 and a possible euro zone debt crisis

Key Points
  • Governments have had to deploy trillions of dollars of fiscal stimulus to mitigate the impact of the coronavirus pandemic, while working with lower revenues and much higher health care and social expenses.
  • While countries with more stable balance sheets should be able to manage the cost of servicing high levels of public debt in the short term, EIU economists said governments will eventually have to confront the debt pile-ups.
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Global GDP (gross domestic product) will not return to pre-coronavirus levels until 2022, and public debt levels will increase sharply this year, according to a new report from the Economist Intelligence Unit.

Coronavirus-induced shutdowns around the world over the past two months have hammered economic activity, meaning governments have had to deploy trillions of dollars of fiscal stimulus while working with lower revenues and much higher health care and social expenses.

As such, in a report Wednesday, the EIU said governments in most developed countries had seemingly concluded that higher public spending, and therefore higher public debt levels, were preferable to the "widespread destruction of productive capacity" caused by the pandemic. This means an inevitable spike in public debt levels this year.

Little room for spending cuts

While countries with more stable balance sheets should be able to manage the cost of servicing high levels of public debt in the short term, EIU economists highlighted that governments will eventually have to confront the debt pile-ups.

What's more, the report suggested, governments will not be able to curb these fiscal deficits through spending cuts.

"Austerity absorbs political capital, and there might not be enough left to pursue such a plan, especially given that the last period of belt-tightening was so recent for many countries," EIU economists said.

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"Governments are also unlikely to be able to make the sorts of savings that could meaningfully reduce debt stocks."

This is because in many economies, the public sector is smaller than it was prior to the 2008 global financial crisis, meaning cuts to public expenditures such as health care are unlikely to be furthered, especially in light of the pandemic reinforcing the necessity of strong health systems, the report explained.

Rather than cut spending, the EIU predicted that governments will seek to raise fiscal revenue, reversing the trend in advanced economies over the last four decades toward lower corporate and personal income taxes.

However, the report questioned whether governments will be able to raise taxes quickly enough for such measures to be sufficient in shoring up economies.

Another euro zone debt crisis

Nine years on from the sovereign debt crisis which rocked the euro zone, EIU economists cautioned that some developed countries may find themselves back on the brink of a crisis. They identified Spain and Italy in particular, both of which were badly impacted by the pandemic and navigating already weak fiscal positions.

"South European states are still recovering from years of austerity, combined with high levels of public debt, ageing populations (which are more vulnerable to severe forms of the coronavirus) and persistent fiscal deficits," the report said

"The European Central Bank would act swiftly to contain the fallout, but a debt crisis in any of these countries would create massive turbulence on financial markets. In turn, the crisis would quickly spread across the globe."

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