The Guest Blog

Guest blog post by Claudia Broyer, Rolf Schneider, Alexander Schramm, Katharina Utermöhl, Allianz Research

The eurozone economy is moving in the right direction, gradually tackling economic imbalances and becoming more resilient. The risk of complacency, however, is high. Europe’s reform journey is still long.

The good: Towards a more stable economy

With 1.5%, economic growth in the eurozone was not exactly booming in 2015. The recovery has, however, become broader and more resilient – as shown by a new report from Allianz Research, the Euro Monitor.

We assess macro-economic imbalances based on 20 indicators in four areas (fiscal sustainability, competitiveness, employment & productivity, private & foreign debt). The individual scores, ranging from 1 (worst) to 10 (best), are combined into an overall rating.

In 2015, the average rating for the eurozone as a whole rose for the third consecutive year. The average rating – at 6.6 points – indicates that the eurozone is now more solid but has a long way to go.

Improvements in economic health were recorded almost everywhere: out of 18 countries, 15 saw their ratings rise in 2015. Moreover, for the first time since 2007, not a single country was in the critical range of 1-4 points, which signals large and dangerous imbalances.

The bad: Lots of room for improvement

Despite moving in the right direction, many eurozone countries still have much work to do before the currency bloc achieves a “good” rating in the 8-10 range. This is most obviously true for Cyprus and Greece, which brought up the rear in our 2015 ranking. But even Germany, which led the ranking for the second year, only just scraped a good rating.

In part, the eurozone’s mediocre rating reflects the crisis’ legacy, including high public debt and unemployment, which are still the two lowest-rated indicators. Given the size of these imbalances, it would be futile to hope that the moderate eurozone recovery will whittle them down.

The ugly: Fiscal consolidation has stalled

The sluggish pace at which economic imbalances are being reduced (a mere 0.2 points last year on average) is a concern. Even more worrying is the outright reversal of reform momentum in one key area: fiscal policy.

While average results improved in the areas employment & productivity and competitiveness, no progress was made on the private debt front. And ratings for fiscal sustainability actually declined slightly – and that although conditions for consolidating budgets would have been favorable, with higher growth and lower interest rates.

Although the average government debt ratio fell for the first time since 2007, it still stands at an excessive 91% of GDP. There is no room for relaxation here.

All countries have work to do

What is clear by now is that it will take a long time to fix the structural weaknesses that many euro countries are grappling with. Maintaining the reform momentum is therefore of critical importance for the future of the euro.

To separate stocks from flows, we calculate a sub-indicator to assess shorter-term progress. This ‘progress indicator’ suggests that – beyond the cyclical recovery which has helped lift all boats – recent improvements have been driven primarily by the former program countries. Those countries that started out with fewer structural imbalances have been less ambitious. While it is not surprising that the more solid countries have less homework to do, the risk of complacency is acute. Finland, the Netherlands, Austria and France have all seen their ranking deteriorate compared with their relative positions in 2000.

Reforms aimed at boosting future growth are still essential – for all eurozone member states. The former problem countries will need a few more years before their return to economic stability is a done deal. The post-crisis clean-up is not finished.

Meanwhile, the leading countries, such as Germany, cannot afford to rest on their laurels. Otherwise, their healthy foundations for growth will be eroded over time.

As the sense of crisis in the eurozone subsides, hardly any governments are still pursuing ambitious reform plans. The reform and consolidation efforts of recent years are bearing fruit, but now is not the time to relax. Even if the turn in the interest rate cycle is not yet around the corner, several eurozone governments need to prepare for it, if they want to avoid renewed doubts about debt sustainability once rates start to rise.

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