Four Major Risks Confront Debt-Stricken Europe In 2012

An NNN-Xinhua News Analysis

BEIJING (NNN-XINHUA) -- With the sovereign debt and banking crises in Europe accelerating, most eurozone economies have suffered a marked slowdown in economic growth, casting clouds over the economic outlook for 2012.

Analysts predict that the Europe debt crisis faces four major risks -- a double-dip recession, a downgrade of sovereign credit ratings, the nkage or breakup of the euro zone, and an acute banking crisis.

RISK 1: A DOUBLE-DIP RECESSION

International institutions have mostly adopted a negative viewpoint on the European economy by downgrading their projections on economic growth since the end of 2011.

The European Central Bank (ecb) projected economic growth of minus 0.4 per cent to 1.0 per cent for the euro zone, compared with its previous estimate of 1.3-per cent growth.

Similarly, the Organization for Economic Co-operation and Development (OECD) has forecast negative quarter-on-quarter growth in the first three months of 2012 for the euro zone.

OECD Chief Economist Pier Carlo Padoan warned in an interview with Xinhua that there are major negative events in the euro area such as liquidity defaults and a significant credit crunch. Those troubles, Padoan said, may spark a generalized contagion and generate an impact on the real economy that could cause severe recession in 2012 and 2013.

Credit rating agency Standard & Poor's was also pessimistic about the outlook for the eurozone economy. It has warned that a mild recession has a 60-percent probability while there is a 40 per cent chance of a more severe slowdown.

"Europe's approaching recession first took hold in Spain, Portugal, and Greece, and the economic woes are now spilling over into the eurozone's core of France and Germany," said Jean-Michael Six, Standard & Poor's chief Europe economist.

Christine Lagarde, THE Managing Director of the International Monetary Fund (IMF), warned in mid-December last year that no country is immune from an "escalating" eurozone crisis and each must act to head off the risk of a global depression.

"It is not a crisis that will be resolved by one group of countries taking action. It is going to be hopefully resolved by all countries, all regions, all categories of countries actually taking action," Lagarde said.

The IMF also cautioned that it is likely to cut its 2012 growth projections as the world economy struggles with a worsening two-year eurozone debt crisis and sluggish growth in the United States.

RISK 2: A DOWNGRADE OF SOVEREIGN CREDIT RATING

Since October, the top three international rating agencies -- Moody's,Standard & Poor's and Fitch Ratings -- have issued warnings that in view of the severe economic situation in the euro zone, most economies in the area appear unlikely to maintain their current credit ratings.

As the second largest economy in the euro zone, France is most vulnerable to the impact of the economic woes and faces the loss of its prized AAA credit rating.

An envisioned downgrade of France's credit rating would be an indication of the escalation of the European sovereign debt crisis, which is spilling over into the eurozone's core.

A chain reaction would likely be set off should France be downgraded. First, there would probably be an increase in the cost of the French government's financing followed by a downgraded credit rating for the European Financial Stability Facility and a possible downgrade of credit ratings for banks and enterprises.

Under such circumstances, European nations and enterprises would be caught in dire straits with no financing sources or government bailouts.

Zhou Hong, director of the Institute of European Studies of the Chinese Academy of Social Sciences, said the most urgent challenge facing the euro zone is how to pay off the enormous debt falling due while the yields of government bonds remain high and refinancing sources scarce.

The latest data released by international financial data providers show that in 2012 the eurozone governments have to settle a debt of 1.1 trillion euros (1.4 trillion USD), including about 300 billion euros coming due in the first quarter of the year.

RISK 3: THE NKAGE OR BREAKUP OF THE EUROZONE

The German news weekly Der Spiegel reported Saturday that the IMF has growing doubts about Greece's long-term ability to reduce its debts.

The Greek government needs to accelerate its consolidation of public debts or else private creditors will see nking returns, the magazine reported.

In an interview with Britain's Sunday Telegraph newspaper, Peter Sands, chief executive of Standard Chartered bank, said the world economy enters 2012 "with a very difficult outlook for the euro zone ... with an increasing possibility of countries actually leaving the euro zone".

In a prospectus released after UniCredit announced that it was selling shares to meet new capital requirements, the top Italian bank warned that if the eurozone crisis worsens the risk that the euro may be abandoned.

"Concerns that the eurozone sovereign debt crisis could worsen may lead to the re-introduction of national currencies in one or more eurozone countries or, in particularly dire circumstances, the abandonment of the euro," the bank said.

The breakup of the region's currency is now "somewhat likely," said Paul Vrouwes, who helps oversee about 12 billion euros of shares at ING Investment Management in The Hague.

"In the past six months the possibility of a breakup has risen significantly from an event that was not likely," Vrouwes said. "I expected more companies to add this risk factor" in their offer documents.

According to media reports, Britain is drawing up contingency plans in the event of a eurozone breakup and some European banks have already set out to make preparations for the possible breakup.

RISK 4: AN ACUTE BANKING CRISIS

With the ripples of the European debt crisis still spreading, commercial banks in Europe are sure to suffer because they hold an enormous amount of government bonds.

Statistics show that coming due in 2012 are commercial bank-held government bonds worth 721 billion euros (929.3 billion USD), including 250 billion euros (322.8 billion USD) in bonds that need to be repaid in the first quarter.

European banks are feeling the credit crunch as investors become wary of investing in their bonds due to continued uncertainty over the impact of the sovereign debt crisis on their balances.

Data released by Dealogic shows that European banks sold 413 billion USD worth of bonds in 2011, equivalent to just two-thirds of the 654 billion USD due to be returned to investors in 2011 as the debts mature.

On Dec. 22, the European Central Bank injected a record 489.19 billion euros (641 billion USD) into eurozone banks via its first-ever three-year refinancing operation. The effort raised hopes that a credit crunch could be avoided and that the added money would be used to buy Italian and Spanish bonds.

A week later, however, due to a lack of confidence in the market, commercial banks put their idle funds back to the European Central Bank, pushing their overnight deposits at the ECB to a record 452 billion euros (588 billion USD).

In addition, European leaders agreed at a summit to strengthen capital adequacy rules for European banks. In order to raise their capital adequacy ratios to 9.0 per cent by July, commercial banks have chosen to sell their assets and tighten credit.

The European economy is likely to be trapped in a vicious cycle if the nking real economy doesn't have credit support from the banking industry. -- NNN-XINHUA