After the initial jolt of Italy’s inconclusive election last month financial markets have largely regained their poise. For now investors are putting their faith and their money in the pledge of the European Central Bank (ECB) to help countries under siege from the markets with unlimited purchases of bonds. But the risk of political shocks, not just in Italy but in other Mediterranean countries, will only increase as long as economies are stuck in recession.
Fourth-quarter output across the euro zone fell by 0.6% compared with the third quarter. Although Germany suffered a similar decline, the economic reverse was much worse on the periphery of the euro area. GDP fell in Italy by 0.9% and in Portugal by 1.8%. Over the past year jobless rates in both countries have lurched up much more than in the euro area as a whole.
Growth is likely to remain elusive because southern Europe is suffering not just from a surfeit of austerity but also from a shortfall of credit. There may be some relenting on harsh deficit-reduction targets for this year. But what is painfully lacking is an improvement in bank lending to accompany the revival of financial markets.
The latest credit figures paint a dire picture for southern Europe. Lending to households in the euro area rose by 0.5% in the year to January, but fell by around 3.5% in Spain and Portugal. The position for non-financial companies was far worse (see chart). Lending to firms dropped by 2.5% in the euro area but that overall figure masks a wide dispersion. Whereas lending rose by 0.9% in Germany, it fell by 3.2% in Italy, by 6.6% in Portugal, and by 11.4% in Spain (a fall exaggerated by the transfer of loans to the state-run “bad bank” in December; the underlying drop was 8%).
The gap in the cost of corporate credit between Germany and the periphery remains wide, especially for smaller companies that cannot access capital markets. The average interest rate on new one-year business loans below €1m ($1.3m) is 2.8% in Germany but 4.4% in Italy, 5.1% in Spain, and 6.7% in Portugal. The dearth of corporate lending – and its expense when it is provided – is a big worry because firms in Europe depend far more heavily on banks than their American counterparts.
The good news is that banks’ funding constraints no longer bind as tightly as they once did. Strong lenders can now finance themselves in the markets. Their weaker brethren have been supported by the ECB’s lavish liquidity programs.
The bad news is that banks still have lots of reasons to lend less (even setting aside subdued demand). Under heavy regulatory pressure to raise their capital ratios, the obvious response for many lenders is to reduce their loan books. Rising amounts of bad debt make lenders more risk-averse. European state-aid rules mean that banks that have been bailed out have to slim down. Others can find it hard to fill the gap for practical reasons: big banks in Spain say that taking on customers of the cajas, the savings banks that are now being shrunk, is complicated by borrowers not having proper documentation.
A recent paper by Luis Garicano and Claudia Steinwender of the London School of Economics looked at the impact of financial constraints in Spain. By comparing firms that are foreign-owned, and therefore have access to other forms of financing, with those that are domestic, and so rely on local banks, the authors can see what uncertainty about financial access did to their decision-making after the 2008 crisis. The Spanish-owned firms cut investment by 19% more than the foreign-owned companies, and reduced employment by 6% more.
If the drought continues southern Europe will be hard-pressed to grow. The ECB’s council was due to meet on March 7 (after The Economist had gone to press). Easing the flow of credit – encouraging securitization of loans to small firms, say, or providing cheap funding for banks that boost lending – ought to be a priority.
© The Economist Newspaper Limited, London (March 9, 2013)