Full political and fiscal union is necessary to eurozone, says F&C’s Scott

Ted Scott, global strategy director at F&C, discusses whether the recent return to growth means the eurozone debt crisis is finally over.

The point needs to be reiterated that for the eurozone to work successfully it requires the policy makers to necessary measures for a full political and fiscal union. There is huge political will to keep the 17 countries intact which analysts have consistently underestimated, but in order to do so it has led to a ‘sticking plaster’ approach which buys time rather than implementing the necessary fundamental reforms.

This includes not only a full banking union but some form of debt mutualisation that integrates the finances of the member countries. Unfortunately the political will to do this remains absent and therefore the muddle through scenario is likely to continue for the foreseeable future.

As the eurozone economy moves back into growth territory it would normally be expected that GDP would accelerate to what analysts term ‘escape velocity’. This means that growth will be sufficiently fast for debt levels to fall and credit growth to accelerate. However, the constraints on growth are likely to remain too large for this to happen because of the political and financial architecture of the currency union.

In the absence of a financial shock (e.g. a country deciding to leave the eurozone unilaterally or a government gaining power committed to withdrawal from the union) the status quo is likely to continue with the Troika, and especially the ECB, providing the necessary crisis support to prevent contagion and keep bond yields suppressed. It is not a solution, however, and the divergent nature of the currency union will mean that growth remains elusive without the necessary fundamental reforms.

This requires significant strides towards a fiscal and political union as well as a common currency and major structural reforms in the periphery countries to remove the obstacles to growth. Such a transformation, if it does happen, is likely to take many years and without it the outlook for growth remains subdued.

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