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Emerging crisis in Europe poses risk to exports [ 2010.03.03 ]

[NewsJapan.org] The financial crisis in Southern European countries has recently emerged as a new risk factor for the world economy. The financial crisis in Europe itself is not anything new since there has long been concern over the issue. After 2009, the budget balance of European countries worsened rapidly due to factors such as the drop in tax revenues and the expansion of public expenditure aimed at addressing the financial crisis and recession. In particular, the five Southern European countries under the degrading acronym, 'PIIGS' (Portugal, Ireland, Italy, Greece, Spain), have been placed on a watch list with significantly high budget deficits, government debt, and unemployment rate.

Accordingly, in December, Greece's credit rating was lowered from A- to BBB+, and Spain's credit outlook turned negative. The premium of CDS (Credit Default Swap) also rose rapidly, setting all-time high records daily in this February.

Greece was the hardest hit country among the PIIGS. The EU Commission of the European Communities raised questions over the effectiveness of the deficit reduction plan submitted by Greece since the credibility of statistics was undermined when the Greek government revised upward its estimate of budget deficits to a large extent. As a result, the market's concern on the national bankruptcy crisis in Greece and possible spillover effects to other PIIGS countries spread rapidly, which substantially increased the volatility of the global financial market. Finally, the EU stepped in to address the crisis, agreeing in principle to support Greece in the Eurozone summit held on Feb. 11 and the financial ministers' meeting from Feb. 15 to 16.

Three reasons can be cited for the recent financial crisis in Southern Europe. The first and biggest reason is the great expansion of public spending for overcoming the economic recession. Southern Europe, whose economic conditions fall far behind when compared to the rest of Europe, was particularly hard hit in its key sectors such as the shipping and tourism industry due to the global recession. This lead to the inevitable accumulation of budget deficits and increase in government debt. As for Greece, its share of budget deficit in GDP climbed steeply from 3.7% in 2007 to 7.7& in 2008, and to 12.7% in 2009.

Secondly, the huge economic stimulus packages were not effective in reducing the deficits in Southern Europe due to the slow rate of recovery. According to the EU Commission of the European Communities, the EU's economy recorded -4.1% growth, even lower than the -2.5% growth of the US. The PIIGS countries posted minus growth in 2009, and their growth in 2010 is expected to remain low, falling under the EU's projection of 0.7%. Moreover, these countries are facing twin deficits, a combination of huge budget deficits and the expansion of current account deficits. This means that there are no other options than reducing public spending or attracting foreign capital to finance budget deficits.

Lastly, the restriction of having to use the Eurozone's single exchange and interest rate policy also contributed to the crisis. For example, Greece and Portugal can improve the balance of current accounts and attract foreign capital by depreciating their currency reflecting the worsened economy and financial crisis. However, the single currency euro remained strong, placing further burden on the two economies. This is in contrast to Korea's fast recovery from the Asian Financial Crisis in 1997 and the recent global crisis, which was based on the weak won that enabled the expansion of exports and surplus of current accounts.

It is projected that the national bankruptcy crisis of Greece will be resolved by its own intensive efforts and the external support from the EU, but the process will not be an easy one, since although agreement for the support was made in principle in the EU summit and financial ministers' meeting, detailed plans are yet to be drawn up. Whereas the EU is first calling for a major budget reduction plan by Greece, the Greek government is requesting tangible support from the EU in advance. Also, due to the significant difference in stance among the EU member countries such as the opposition from Germany and Northern Europe based on concerns over increased burden on their economies, a considerable amount of time will be needed to set up a specific relief program. Therefore, it is predicted that support from the EU will take concrete shape in March after the evaluation on the Greek budget deficit reduction plan is completed.

Although urgent issues were taken care of, a recurrence of the financial crisis is still possible due to two reasons: 1. The influence of the crisis is not limited to Southern Europe including Greece. 2. The crisis cannot be resolved in the short term. The budget deficit in the GDP of the EU as a whole is also on the rise, recording 6.9% in 2009, and 7.5% in 2010, and the US and Japan are no exceptions. Europe and other advanced countries are now facing a dilemma because austerity measures are required in order to secure fiscal health, but at the same time, economic stimulus through the expansion of public expenditure is also crucial in achieving a fast recovery. Therefore, Europe's financial crisis is projected to remain as a potential anxiety factor amid continued uncertainty in the near future.

Korea is not likely to receive direct influence from the recent financial crisis in Southern Europe since its share of exports to the PIIGS countries only recorded a mere 2.37% in 2009. Moreover, although Greece takes up the largest proportion among the five countries, exports for this year will not be significantly influenced since vessel exports, which comprise the majority of Korean exports to Greece, will still be carried out as long as the vessels are under construction.

Korean exporters should heed the increase of volatility in the exchange rate between the won and the dollar stemming from the growing uncertainty in the global financial market. This, however, can also bring a positive effect of preventing a free fall of the dollar-won exchange rate by stopping the global trend of the weak dollar. In other words, such uncertainty can raise the exchange rate to slow down the speed of won's appreciation, which is a potential impediment to the recovery of Korean exports.

However, Korean exports may be negatively impacted if the overall economy of the EU takes a downturn by a prolonged financial crisis. In fact, the exports to the EU in 2009 accounted for 12.8% of Korea's total exports, ranking second after China, which accounted for 23.9%. Furthermore, the recovery of the global economy is predicted to take a blow if the effect of the economic stimulus by the EU member countries is weakened due to the reduction of public spending aimed at securing fiscal health. The PIIGS countries already face a considerable reduction of government budget in order to cut down on excessive budget deficits. Also, the possibility of a crisis in one member country spreading to the whole EU still remains since the EU's major areas of trade are concentrated within the region.

In conclusion, the European financial crisis that started in Greece is an ongoing process. It is a potential threat that can seriously damage the vulnerable world economy which is still in recovery. Under the strong international collaboration established after the global financial crisis, it is true that, for any country, the possibility of an extreme case such as national bankruptcy is not high. However, we should still remain cautious because as we saw in Lehman's case, the global financial market can instantly fall into a crisis solely by a panic-triggered chain reaction.

In this regard, even though the short-term effect of the European financial crisis is limited, its long-term effect should be recognized as a potential risk in the sense that the crisis increases the uncertainty in the financial market and impedes the recovery of the global economy. Against this backdrop, the Korean government and exporters should remain vigilant on Europe's situation when taking into account Korea's high external dependency and sensitivity to external shocks.

LEE Seung Jun
Senior Researcher
Institute for International Trade, KITA

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