Eurozone February 05, 2020 / 02:23 pm UTC

Eurozone: Health Checks Other than Public Debt

By Giacomo Pallaro

Bottom line: Twelve years since the Eurozone fell into the GFC, economists and financial markets are increasingly alert to macroeconomic imbalances that could accentuate a temporary drop in activity into a more severe recession. The elevated stock of public debt is a well-known factor to watch out for, but is just one component of the broader net international investment position. Marked differences exist within the Eurozone, with countries normally thought as resilient displaying more worrying positions than the “usual suspects.” 

Figure 1: Ample Variability in the Eurozone Between Net Lenders and Net Borrowers (NIIP, % of GDP)

Source: Eurostat, Continuum Economics

There Is More Beyond Public Debt

Elevated public debt is a well-known cause of concern for macroeconomic activity as it limits governments’ countercyclical spending and crowds out funds that could be used in a more productive way than in debt servicing. The constraint on the fiscal lever is particularly painful for countries in a common currency area, such as the Eurozone. With, broadly speaking, around half of Member States’ public debt held domestically, the trading activity by foreign investors can cause material swings in bond yields, as seen during the sovereign debt crisis. Beyond the public debt, however, it is worth analyzing an economy’s overall net exposure to the rest of the world to assess the degree of dependence on foreign investment and the ensuing risk of contagion should those foreign economies face a downturn. 

Dependence on Foreign Financing 

The Net International Investment Position (NIIP) represents difference between the stock of external assets held by domestic residents and the stock of domestic assets held by foreign residents. The NIIP is essentially the accumulation over time of past current account deficits and surpluses (adjusted for regular valuation changes, for example, the writing off of non-performing loans, equity revaluations or changes in the exchange rate).

With a NIIP of -1.1% of GDP in Q3 2019, the Eurozone is a net debtor toward the rest of the world as its liabilities exceed its assets. Put differently, it is financed by the rest of the world. However, this net borrowing has been declining steadily since the peak at 20% of GDP in 2009 Q1, as a result of the accumulation of current account surpluses since 2012. Additionally, the Eurozone’s net debt is far from large when compared to the U.S. (whose NIIP exceeds $10.5 trillion, or around 45% of GDP), Australia (with over $650 billion, over 40% of GDP) or the UK (with over $500 billion, or 15% of GDP). Continuing the international comparison, at the other end of the spectrum we find the largest net lender being China ($3.6 trillion, 26% of GDP), followed by Japan ($3.4 trillion, over 70% of GDP).

However, variability in NIIP exists also within the Eurozone. For very different reasons, Ireland and Greece are net borrowers at over 150% of their respective GDP, with the former receiving large amounts of net foreign investments in relation to the activities of multinational corporations that relocated in the country, while the latter reflects the post-crisis international financial aid. More relevant for the stability of the Eurozone is Spain’s large negative NIIP, implying a dependence on foreign financing, worth around 80% of GDP. Although the available data provides only a very limited breakdown on Spain’s partners, it is not unreasonable to expect that most of the net financing comes from other EU Member States. This conjecture is supported by the large net lending position posted by Germany (almost 70% of GDP) and the Netherlands (around 90% of GDP). Although facilitating capital flows from net savers to net borrowers is one of the key aspects of a common currency, it makes easier to withdraw funding, too.

Spanish NIIP Large but Improving… France the Opposite

Despite the recent improvement thanks to the accumulation of current account surpluses in recent years, the Spanish net debtor condition is the one to watch. Although being a net borrower in NIIP terms means being able to attract foreign investment into the country, it also means “to rely on the kindness of strangers,” as outgoing Bank of England Governor Mark Carney once said for the UK. In other words, should the domestic economy struggle, political uncertainty exacerbate or the economic conditions of the lenders worsen, the net borrower could lose the external financing or be forced to offer higher—and potentially unsustainable—returns on the foreign investment. For example, with a negative net portfolio investment position of nearly €550 billion, a 10% withdrawal of funds from foreign investors, which is not unprecedented as it happened during the GFC, would require finding alternative resources for around 4% of GDP. More generally, though, any easing in Spain’s ability to attract foreign capital would severely affect the robust GDP growth rate experienced in recent years.

In contrast to Spain’s improvements after its NIIP reached close to 100% of GDP in 2014 Q1, the French NIIP has been gradually worsening from a slightly positive (i.e. net lending) position at the beginning of 2000 to a net borrowing position of worth around 25% of GDP. While this level is not worrying yet, it should not be underestimated as it is expected to worsen in the future due to rising public debt (now at around 100% of GDP) and imports growing faster than exports, resulting in a net importing position.

Interestingly, despite having one of the largest public debt/GDP ratios in the world at around 137%, Italy’s NIIP is nearly balanced, with a net borrowing position of just 3.1% of GDP, which is likely to turn into a net lending position over the next few years. We do not want to underplay the importance of the large stock of public debt that is immobilizing the Italian economy by providing almost no room for the government to maneuver. However, the country’s ability to export provides a lifeline that helps public debt sustainability, at least in the short term.

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I, Giacomo Pallaro, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.