No Quick Recovery for Europe

EuropeJust before the weekend, Germany nosedived into a recession after the Statistisches Bundesamt, the country’s statistics bureau, announced a 2.2 percent contraction of GDP over the first three months of 2020. The economy shrank 0.1 percent in Q4 2019. A recession is defined by two consecutive quarters of negative growth.

Germany’s Q1 2020 contraction compares favourably to those registered in France (-5.8%) and Spain (-5.2%) and is at par with the UK (-2.2%). Across the Eurozone, economic activity retreated by 3.8 percent during the first quarter of the year in the sharpest decline since the crash of 2009.

German Economy Minister Peter Altmaier warned that the worst is yet to come and said the nation must prepare to face the deepest recession since the founding of the Federal Republic in 1949. Analysts predict GDP will have lose 6.3 percent by the end of the year. However, Mr Altmaier tried to strike a note of optimism by forecasting that the economy will bottom out next month and stage a strong rebound thereafter with in 2021 GDP growth expected to reach 5 percent or more. A preliminary set of data for April, published by the German central bank, shows a further 4.6 percent slump in economic activity.

The German Institute of Economic Research (Deutsches Institut für Wirtschaftsforschung – DIW) dismissed Minister Altmaier’s optimism as ‘wishful thinking’ and pointed out that the economy is hostage to the novel virus and any recovery remains highly dependent on its successful containment. Moreover, the fortunes of Germany’s large export-oriented corporations are tied to global markets. They may be amongst the first to feel the pinch of increased protectionism and a tentative unravelling of long and complex supply chains.

Market watchers are growing sceptical of policymakers who promise a swift return to strong growth and look to China, the first major economy to emerge from a lockdown, for signs that the recovery may more sluggish than anticipated. Lingering effects such as depressed consumer and business confidence may dampen growth and prolong the recession to a significant degree.

The German government has done more than most to shield businesses and households from the fallout of the pandemic. Breaking resolutely with its tradition of fiscal frugality and prudence, the country swiftly rallied its considerable financial resources to weave a robust safety net. In March, large corporations effectively received carte blanche to draw whatever funds needed from state-owned development bank KfW Bankgruppe which was set up in 1948 to help finance post-war reconstruction and, as such, possesses a vast institutional reservoir of knowledge on breathing life into a ravaged economy.

Smaller businesses and self-employed workers enjoyed easy access to a €50 billion support fund that managed to cut cheques in record time with beneficiaries receiving cash only days after putting in their first application. The state also took over 90 percent of payroll expenses of furloughed workers without attaching many – or indeed any – conditions to its largesse. Most employers merely had to ask for support to be almost instantly granted. In some cases, businesses were able to claim full compensation for idling employees.

According to the International Monetary Fund (IMF), no other country acted so decisively, swiftly, and forcefully to help its citizens and companies weather the pandemic. However, as the new normal set in, cracks began to appear in the system as a disconcertingly large number of small- and medium-sized businesses may have misused the support and major corporations tapping into KfW funds, such as Volkswagen and BASF, announced their intention to keep paying out dividends.

The government has since tightened the rules to assert a measure of control over corporations that make use of emergency funding. However, that has not diminished Berlin’s willingness to support the icons of German industry. It now mulls a series of generous cash incentives to get Germans to buy new cars. The partial re-nationalisation of troubled flag carrier Lufthansa is a done deal in all but name. The government is expected to take a 25 percent stake in the company and will inject whatever funds necessary to keep Lufthansa aloft. Earlier, the governments of France and The Netherlands also promised to do whatever it takes to ensure the survival of their flag carriers.

The European Union has withdrawn its opposition to state aid for privately-owned companies and greenlighted the interventions. It had little choice since governments had clearly signalled their intention to ignore any and all objections raised by Brussels, citing force majeure clauses included in the EU rulebook.

The impressive volumes of state aid made available by the countries of northern Europe contrast sharply with the patchwork of relatively modest support measures decreed in the hard-hit countries of the south.

Spanish plans to introduce a universal income had to be shelved due to budgetary constraints. Support measures that look robust on paper, turn out to be wrapped in a complex web of byzantine-like regulation with exemptions that can be applied to almost any business. The Spanish economy boasts an exceptionally rich and diverse environment of smaller, often family-owned, businesses that poses challenges in delivering state aid to where it is needed most.

Similar troubles initially plagued the British government as well. The disbursement of financial support through high street commercial banks stagnated due to complex regulation and the misinterpretation of rules. At first, many banks refused to assist companies that obtained most of their revenue from export sales. It took repeated official clarifications to remove this misapprehension. Most banks also insisted that entrepreneurs put up personal guarantees in order to receive emergency loans. A second support package removed most of these stumbling blocks and managed to speed up the placement of emergency loans.

Last week, Chancellor of the Exchequer Rishi Sunak promised to keep all present support measures in place until October, scrapping plans to reduce state support for furloughed workers from 80 percent of their salary to 60 percent as of July. The British government has so far refrained from providing large-scale support to the airline industry, forcing British Airways to lay off 12,000 workers and Virgin Atlantic to trim its fleet. Irish carrier Ryanair, Europe largest airline by passenger volume, has also been denied support though its outspoken CEO Michael O’Leary does not complain other than to object to state aid for his rivals which he claims distorts the market.

Of all Eurozone member states, Italy is hit hardest by the virus. The country’s economy is expected to contract by as much as 9.5 percent this year with more than 10 million Italians being demoted from the middle class to a precarious existence at or below the national poverty line. In order to limit the social consequences of the pandemic, the government in Rome late last week unveiled a €55 billion package with goodies for all sectors of society. The legislation covers 464 pages of text and 256 separate articles that provide detailed specifics to who receives what, where, and how much.

Most pundits agree that, whilst well-intentioned, the support measures are unlikely to prevent a major economic meltdown. Both Spain and Italy need substantial financial contributions from northern EU member states in order to return to growth and avoid the recession from cascading into a depression. Later this month, after the European Commission has finished taking stock of the damage, European leaders will reconvene to discuss a major aid initiative that will probably run into the trillions of euros.

The formerly recalcitrant Dutch have already indicated that they may collaborate with initiatives that stop just short of the direct mutualisation of debt and risk. Last month, the Dutch government played ‘bad cop’ and abruptly broke off discussions over eurobonds and other forms of debt pooling, causing an uproar in Italy and Spain. The country was widely seen to act as a proxy for Germany which remains reluctant to offend southern EU member states after it was savagely castigated for its brutish treatment of Greece during the 2010 banking crisis. A Pan-European economic rescue package is expected to be agreed upon by next month offering a modicum of solace to Spain and Italy.

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