Europe on the edge of the abyss: States are fighting to stave off recession | Economy
Almost six months after Vladimir Putin ordered Russian troops into Ukraine, the extent of the damage to Europe’s economy is becoming clear. The red lights of recession are flashing.
The four major eurozone economies – Germany, France, Italy and Spain – have all had their growth forecasts for 2023 downgraded by the International Monetary Fund, the combination of war and the rise in interest rates having slowed down activity.
In the UK, inflation is above 10% for the first time in 40 years as households grapple with rising energy bills. The Bank of England expects inflation to peak above 13% in the fall after a further rise in energy costs, while the economy falls into a long recession.
As Britain faces additional Brexit pressures, the impact of soaring energy prices, supply chain disruptions, worker shortages and drought are also hitting the rest of Europe. Analysts at the Economist Intelligence Unit say the pain could last for some time, as countries have to wean themselves off Russian hydrocarbons, and building renewable energy as an alternative will take time.
“In the short term, we expect a recession in Europe in the winter of 2022-23 due to energy shortages and sustained high inflation,” the EIU said. “The winter of 2023-2024 will also be difficult, and so we expect high inflation and sluggish growth until at least 2024.”
Here we assess the risks of recession in the EU – and in Russia.
Europe’s largest economy is at the center of the storm, as the energy crisis, months without rainfall and a disruption in global trade hit its manufacturing base. Economic growth slowed to a halt in the second quarter and is expected to turn negative in the coming months.
“It will take an economic miracle for Germany not to fall into recession in the second half,” said Carsten Brzeski of Dutch bank ING. “The fact that the entire German economic model is currently in need of renewal will also weigh on growth prospects in the years to come.”
Russia supplied more than half of Germany’s gas in 2020 and about a third of all oil. Since the outbreak of war, the Kremlin has throttled supplies, blaming technical problems for a drop in volume through the key Nord Stream 1 pipeline.
Drought and scorching temperatures have caused a sharp drop in water levels on the Rhine, a key transport route for Germany’s dominant industrial sector. Water levels fell below the critical 40cm mark, preventing barges from being loaded to capacity. Some routes were canceled, causing delays for chemical companies and other manufacturers of industrial cores. Factories along the banks of the Rhine that rely on water for cooling have also faced problems, while shipments of coal to power stations – which had been intended to keep the lights on – risk being disrupted. .
In response to the energy crisis, Berlin will impose a gas tax for households, which will take effect in October and last until April 2024, which aims to spread the higher wholesale cost between households and industry.
The government has put in place an energy support package worth more than €30bn (£26bn), including a €300 lump sum for workers, extra help for people on social assistance, tax reductions on petrol and diesel and reduced bus and train tickets of 9 euros. .
German Chancellor Olaf Scholz has also pledged a new financial support package.
Chances of recession (out of five)
France should be better insulated than many other European countries, thanks to its large nuclear power sector, which accounts for just over 70% of its electricity production, but it is struggling with serious reactor failures aging. Although in a less precarious position than Germany, the eurozone’s second-largest economy could still face damaging power cuts this winter.
GDP increased in France by 0.5% in the second quarter, which is lower than that of other countries on the continent, with particularly weak domestic consumption. The government has put in place an emergency support plan worth 20 billion euros, including tax cuts at petrol pumps, while capping the increase in regulated fuel prices at 4%. electricity, a policy aided by public ownership of energy giant EDF.
Italy’s economy has recently performed much stronger than its major eurozone rivals, growing 1% in the second quarter. But like Germany, Italy is heavily dependent on Russian gas and has the added complication of being plunged into a new bout of political uncertainty following Mario Draghi’s resignation as prime minister earlier this summer.
Opinion polls point to a change in direction from Draghi’s technocratic approach after the upcoming elections. A right-wing coalition government that campaigned on a strongly nationalist and protectionist economic platform should win.
Financial markets and the European Central Bank are already aware of the risks of investors demanding a higher interest rate premium for buying Italian bonds. With Italy firmly in mind, the ECB last month announced a new financial instrument designed to prevent rising interest rates from having a disproportionate negative impact on the most vulnerable member states.
In early August, Italy approved a new aid package worth around 17 billion euros for consumers and businesses, in one of Draghi’s last acts as leader. A petrol and diesel tax cut, which was due to expire this month, has also been extended until September 20.
Since the creation of the single currency almost a quarter of a century ago, Italy has been the worst performer of the “big four”, with a standard of living barely higher than in the late 1990s. It enjoys this year from a boost to tourism, which accounted for 13% of its GDP before the pandemic.
Like all other countries in Europe, Spain is affected by the war in Russia, but of the big four, it has the best chance of avoiding recession, despite soaring inflation.
There are a number of reasons for this. Its economy entered the crisis in fairly good shape and, like Italy, was boosted by the surge in tourism after the pandemic. Tourism accounted for 12% of Spanish GDP before Covid and an even bigger share of employment.
But Spain is much less dependent on Russian energy than Italy and is already a major importer of liquefied natural gas from around the world. GDP grew 1.1% in the second quarter and the IMF expects it to see the fastest growth of the big four next year.
The government has put in place €16 billion in financial aid and loans to help businesses and households cope with soaring energy costs.
Russia has suffered from Western sanctions, plunging its economy into a deep recession and forcing the Kremlin to default on its foreign debts for the first time since 1918, although soaring energy prices helped to soften some of the impact.
Yale University researchers said last month that the West was crippling Russia’s economy, though other experts disagree. Holger Schmieding, chief economist at Berenberg Bank, said recent data did not point to such a “stark conclusion”.
Russia’s current account balance – measuring trade and investment flows – more than tripled to a record surplus of $167 billion in the second quarter, helped by high wholesale oil and gas prices which have inflated exports, while Western sanctions led to a drop in imports. The proceeds have been a vital source of hard currency for Moscow, reflected in ruble-erasing losses seen since the start of the invasion.
However, in the long term, experts say the Russian economy will struggle with the loss of Western technology and investment. “Our best guess is that Russia is in a major recession but still far from catastrophic,” Schmieding added.