The Ongoing Debt Challenge in Europe

August 08, 2012 | Tom Salemy, CFA, CAIA, Managing Director

This week’s Chart of the Week highlights the euro area’s ongoing debt problem. As the chart above shows, through the first quarter of 2012, euro area governments’ debt-to-GDP ratio stood at 88.2%, up from 87.3% at the end of the fourth quarter of 2011. This was the eighth debt-to-GDP increase in the last nine quarters. Since the fourth quarter of 2009, only four countries (Estonia, Hungary, Sweden, and Norway) have reduced their debt-to-GDP levels. The countries with the highest government debt-to-GDP ratios at the end of the first quarter of 2012 were Greece (132% despite the most recent debt write-down), Italy (123%), and Portugal (112%). The lowest ratios were Estonia (6.6%), Bulgaria (16.9%), and Luxembourg (20.9%).

Even though many of the most indebted countries have instituted rigorous austerity cuts, debt-to-GDP levels have continued to rise, mostly due to a lack of growth. Severe austerity cuts have resulted in larger than expected decreases in GDP, which has led to continued increases in debt-to-GDP levels. For example, Italy has contracted more than expected for each of its prior two GDP releases (-.7% and -.8%). Furthermore, on July 27, the IMF lowered Spain’s 2012 GDP forecast from -1.5% to -1.7%.

It is no secret that the euro area has established very stringent debt and deficit ratios for the weakest members. However, with euro area unemployment at 11.2% (much higher in certain countries such as Spain, whose rate is 24.6%) and a systematic lack of growth, euro area leaders must find a way to establish policies that will allow for economic expansion alongside spending reductions. Until this happens, economic growth and capital market performance from these countries will likely remain choppy.