Wednesday, May 16, 2012

Backlash against austerity in Eurozone

France, Greece, the Netherlands- and now in a provincial election in Germany. Voters are telling their masters: to hell with austerity. Does this mean governments can or should spend their way out of trouble? No way. Where is the money going to come from? Not from private investors: any escalation in spending will get a thumbs down from the financial markets. Official flows, from within or outside the EU, will also not be forthcoming. (Germany is not willing to bankroll deficits elsewhere without tough conditions and, indeed, that is the trigger for the current backlash).

So, the idea that new governments can repudiate the fiscal compact signed in March is sheer delusion. Some of the austerity targets can be moved back; there could funding for select projects. Otherwise, the substance of the austerity conditions will stay. This means that Greece will have to leave the Euro because it is one place where austerity has no chance of producing results even over ten years. What then? Spain, Portugal, Italy all will find the going rough weather. And if Greece finds its feet after default, they too would be sorely tempted to exit the Euro.

So, Germany and other pro-Europe countries in the EU face a stark choice. Either they are willing to back austerity with a measure of debt forgiveness, which alone will make the austerity conditions viable. Or it''s The End for the Euro.

More in my ET column, Markets can trump voters. 

Let me add a footnote. What would be the implications of a Greek exit? There would be chaotic conditions in the markets but, on balance, the crisis can be contained using the financial muscle of the EU and the IMF. However, it does mean that in 2012, uncertainty in the financial markets will continue as in 2011. That's bad news for investment in general and in India in particular. Unless the ongoing crisis is quickly contained, our hopes of a modest acceleration in growth will take a beating.

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