Moody's: Euro area recovery ongoing, but reform efforts are fading and political risks rising

While euro area sovereigns' ratings will likely remain stable in 2016-17, fading fiscal consolidation, limited progress on structural reforms and an increasingly fluid political landscape limit upside potential and create longer-term risks, says Moody's Investors Service in a report published today. 

According to Moody's, the credit quality of euro area sovereigns is supported by moderate economic growth and stabilizing debt-to-GDP ratios. The main downside risk is of much lower than expected growth in China damaging the global economy, but this is not Moody's baseline scenario. 

"Moody's expects growth across the euro area to be around 1.5% of GDP in 2016. While that is low by historical standards, it will support euro area sovereigns' credit profiles over the coming year or so," says Thorsten Nestmann, a Vice President-Senior Analyst at Moody's and lead author of the report. "However, we see little upside to ratings, and a number of clouds gathering." 

Debt loads remain stubbornly high, with the deleveraging process hampered by a combination of low growth and low inflation. "We expect inflation to be around 0% on average in 2016 and to only gradually increase towards 1% in 2017. The longer inflation stays low, the longer the deleveraging process will take and the longer the euro area economy will be vulnerable to negative shocks," adds Mr. Nestmann. 

Moreover, progress on structural reforms has been limited at both national and euro area level, and support for further efforts is eroding against the background of a fluid, unpredictable political landscape which has seen a number of challenges to the established order across Europe. 

The UK's potential exit from the EU could create further obstacles to reform within the EU and also the euro area, and even poses risk to established programmes, if it encouraged the growth of anti-establishment or even secessionist political parties in euro member states. 

The refugee crisis is a further source of disunity in the EU that adds another obstacle to longer-term integration within the euro area, impairing the currency union's capacity to absorb shocks by increasing political tensions within and between member countries. 

Given low inflation and reduced structural consolidation, Moody's expects only a very gradual reduction in euro area sovereigns' debt levels in the years prior to 2020. 

http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_1012395