Is the European Economy in Danger of Japanization?

Risks in the Eurozone from a Banking Perspective


José Luis Martínez Campuzano

José Luis Martínez Campuzano, strategist for Citibank, during the session at the Madrid campus / Photo: Javier Arias

“I am convinced that Europe will avoid a third recession, but we are undoubtedly facing a risk of weak growth in the coming years and that is dangerous for the economies of the continent.” This statement by Citibank strategist José Luis Martínez Campuzano, was made during a continuous education session organized by the IESE Alumni Association.

It summarized the opinion of many experts about Europe's economic outlook. In Martínez Campusano's opinion, Europe is troubled primarily because it is immersed in an unfinished deleveraging process. However, things could improve if the eurozone countries do something soon to reduce their massive debt, the root of the current crisis.

To achieve this, Martínez Campuzano cited four necessary measures that the stewards of Europe's economies must take:

  • encourage patience 
  • lay out eased financial conditions
  • promote the onset of inflation
  • implement restructuring to facilitate debt repayment

The expert strategist also stressed the importance of the European economy becoming more productive through the pursuit of new investments and greater flexibilization. “Better funding is imperative, but something else is needed. There must be more leeway for the deleveraging process and for flexibilization to foster potential growth of the eurozone economies," he added.

A Complex Situation

Europe is in a complex situation due to discrepancies between the major central banks regarding monetary policy, political differences and the crisis of confidence of European institutions. All of these elements impede economic progress, but the Citibank analyst believes that some rays of hope remain.

“The important thing in situations like this is to survive and buy time and, so far, that is what we're seeing," he said.

IESE Prof. Juan José Toribio agreed that despite the recovery in some peripheral countries like Spain, Europe is one of the current problems of the world economy. “Any stimulus of our domestic demand and the progress of structural reforms undertaken in recent years depend on what may happen in the European economies," he said.

Alberto Gallo, Director of the Royal Bank of Scotland, was less optimistic, pointing out the real risk of "a Japanization of the European economy" (a long period of slow growth with no inflation, or negative inflation, despite the monetary stimulus initiatives of the ECB). “Us having low interest rates and the ECB having injected liquidity into the system doesn't mean there will be growth. The strategy has not worked and we are approaching the dangerous milestone of falling to 0% inflation," he added.

Buying Covered Bonds

In order to avoid falling into the abyss and to maintain at least a slow level of growth, Gallo said there must be greater connection between fiscal policy and economic policy in the eurozone, which implies having political will. According to the economist there are two elements that are potentially vital for the survival of the European economy. First, the immediate purchase of covered bonds and asset-backed loans (ABS) by the ECB to facilitate new flows of credit and raise the balance. In this regard, Gallo ruled out the purchase of sovereign debt by the entity led by Mario Draghi, at least for the moment.

ROI is the second essential factor that should boost the eurozone. Over the past decade, Europe has seen a 19% drop in investments, a worrying statistic that requires action. Gallo pointed out that low interest rates do not guarantee increased business investment, since companies are cautious and hesitant in a situation like this. “What we really ought to be concerned with is whether Europe is a good investment," he said.

The job market reforms introduced in countries such as Spain, Italy and France could help build trust among investors. “The credit crunch has already been mitigated and deleveraging has stabilized," said Gallo. He noted that the low levels of risk premium are another positive aspect in the European markets.

Despite these rays of optimism, latent risks remain and 2015 may yet be a difficult year. Structural reforms are still pending, progress must still be made toward bank disintermediation and growth forecasts are low. Political risk, including elections in countries such as Greece, could also endanger the stability of the euro. “Our margin of error is dwindling. The next three years are vital if we hope to move forward and I am concerned about the fact that, looking ahead to 2015, the ECB will struggle to maintain profitability," Gallo concluded.