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Europe in limbo - Home and dry
May 26th 2012 | London, Madrid and Rome | from the print edition
THE joke recounted by the boss of a large Italian bank is an old one, but it
captures the moment. Two hikers are picnicking when a bear appears. When one
laces up his boots to run, his friend scoffs that he can t outrun a bear. The
shod hiker retorts that it is not the bear he needs to outrun, merely his
fellow hiker. We re sitting at the picnic with our boots still on, says the
bank boss.
As policymakers and pundits try to work out the effects of a Greek exit, banks
and investors have already been taking precautions. One course of action has
been to pull money out of more fragile markets. Never mind the weakest
economies like Greece, Ireland and Portugal; Spain and Italy have also lost
foreign bank deposits of about 45 billion ($56 billion) and 100 billion
respectively from their peaks. Add in things like sales of government bonds by
foreigners (see chart 1), and capital flight is probably equal to about 10% of
GDP in those countries, say Citigroup analysts. Such outflows are hard to stop.
The European Central Bank (ECB) has filled this funding gap by providing
liquidity to the banks. But that has in turn reinforced the second
precautionary tactic: matching assets and liabilities within countries as much
as possible. It is a common refrain from bankers that the euro area no longer
functions as a single financial market, although that has the paradoxical
advantage of making a break-up less destructive. Banks have used ECB loans to
borrow from the national central banks of the countries in which they have
assets; that should mean that both sides of the balance-sheet would get
redenominated in the event of a euro exit.
Much of that ECB liquidity is meant to find its way into the real economy, of
course. But the third precautionary technique, for both lenders and borrowers,
is to hang fire while uncertainty is so high. The Economist has compiled a
credit-crunch index, comprising a number of measures on everything from bank
lending to the cost of buying insurance against default for banks, firms and
sovereigns in the euro zone. A single index disguises big differences between
weaker and stronger states, but it shows that credit is crunchier now than it
was at the height of the banking crisis in 2008 (see chart 2).
Much economic activity is being strangled as a result. In Spain firms have put
bond issues and asset sales on hold. Volatility makes it almost impossible to
value an asset, bankers say. The Catalan government failed to sell 26 buildings
in Barcelona earlier this year for about 450m because one of the bidders
wanted to introduce a clause that said rents would be paid in dollars in the
event of a euro break-up; the other bidder pulled out because it had been told
by headquarters to hold off on deals in southern Europe.
The number of Spanish companies filing for bankruptcy climbed by 21.5% in the
first quarter. Nearly a third of these were in the property or construction
industries, but the rot is spreading. Alestis, an aeronautical supplier to
aircraft manufacturers, filed for bankruptcy earlier this month after failing
to reach an agreement with banks to refinance its debts.
The sound of credit crunching can also be heard next door in Portugal, where
loans to non-financial companies fell by 5% in the first quarter compared with
the same period last year, and credit to households by 3.6%. One of the
conditions of the country s bail-out programme is that banks should reduce
their total loans to 120% of assets. The quickest way to do that is to avoid
making loans.
Conditions are little better in Italy. The province of Varese, near Milan, is a
manufacturing heartland: its factories make plastics, textiles and a range of
engineering products. Once firms there griped about poor infrastructure and red
tape; now the credit squeeze is their main complaint. The local bosses
association says that 40% of firms were hit by lowered borrowing ceilings
between January and March, and 15% were told to pay back loans. Banks turned
down 45% of requests for new funding.
Those loans that are extended carry hefty interest rates, in part because
higher sovereign-borrowing costs have a knock-on effect on banks funding
costs. Differences in sovereign rates can be self-reinforcing, especially when
German firms across the border are rivals. A marginal northern Italian company
competing against an equal company in Bavaria will go bust, says the boss of
one bank. Then the cost of risk goes up and has to be shared by all the other
small companies.
If firms cannot borrow from banks they lengthen payment terms to their
suppliers, exacerbating the credit problem, says Michele Tronconi of Sistema
Moda Italia, a body representing textiles and clothing firms. Fashion is Italy
s second-largest export industry, but no sector has a higher level of
non-performing loans.
This credit squeeze will have tightened since Greece s inconclusive election
this month. That further dents growth prospects: estimates by Now-Casting, a
forecasting firm, suggests that euro-zone GDP will contract by 0.2% in the
second quarter. That in turn risks worsening the debt dynamics of the zone s
peripheral countries at just the wrong time. Policymakers keep trying to buy
time to solve the crisis, but they may be only speeding the end they are trying
to avoid.
from the print edition | Finance and economics