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Economics: It will take more than a General Election to tackle the UK’s fiscal deficit

The opening months of 2010 marked a shift in outlook for Europe. Last autumn’s optimism about recovery has now been replaced with concerns about the sustainability of growth in the single currency area. And the issue of Greek debt (and associated concerns about other southern European members) has contributed to turbulence in financial markets, putting considerable pressure on euro policymakers.

There is little doubt the financial statistics that allowed the Greeks to join the single currency were massaged and they have now been rumbled. By last October it was apparent that the government deficit was not the six percent of GDP that was originally claimed but more likely to top 12 percent. Greece’s massive and undeclared budget shortfall means its public sector debt is more than four times the eurozone limit.

As a result, the government has come under intense pressure to get its finances in order, mostly by cutting spending. But proposed austerity measures have been met by strikes. The euro currency has taken a beating against the dollar and European leaders have been debating what support might be offered to the beleaguered Greek government – testing the purpose of the union.

This debt crisis has several dimensions. For the Greeks themselves, the prospect of many years of slow growth and fiscal constraint is probably unappealing and may make some people wonder whether the cost of eurozone membership is too high. For the major players in the area, such as France and Germany, the suggestion that they offer some sort of aid to Greece at a time when their own fiscal positions are far from robust is not a welcome one.

The possibility of contagion cannot be ignored. Financial markets have come to view the euro area countries in three blocs. This sentiment depends on a mix of factors, such as the current deficit and the cumulative debt relative to GDP. While the current account balance is obviously in poor shape, it is not alone. Portugal, Italy and Ireland can all be bracketed with Greece and if support were available to one, requests from the others would be hard to resist. But not offering help could pose a risk to stability of the currency area as a whole.

It might seem that being outside the single currency affords the UK a measure of protection from this uncertainty. But in an integrated, global economy there is no immunity. The UK will depend on exports to underpin recovery, particularly as households and the public sector are boxed in by debt. Weaker sterling has given British companies an edge in international markets but the fact the benefits have been slow in coming through reflects the UK’s traditional dependence on slow-growth markets such as Europe.

About half of the UK’s overseas earnings come from the European Union. Although only a relatively small country, we actually export more to Greece than we do to a key emerging country like Brazil, while India and China each accounts only for about twice as much as Greece. The deficit problems in Greece, together with the knock-on effects on the rest of the eurozone, are a major negative for the pace of UK recovery.

The UK’s deficit, debt and current account indicators rank it closer to Portugal and Spain than Germany, which has raised fears of a downgrade of the country’s credit rating. This will increase the cost of government borrowing and aggravate a debt problem that, at present, seems affordable.

A decisive outcome in our General Election with the promise of firm action to tackle the fiscal deficit will reduce the likelihood of a downgrade. But Greece’s problems should emphasise that there is no hiding place. Any feelings we might have of schadenfreude about Greece and the euro are misplaced.

Dennis Turner is chief economist at HSBC

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