The next and more serious phase of the European crisis
Two upcoming political events could usher in a new, worse phase of the European debt crisis

Rob Green/Bergman Group

Article Highlights

  • French presidential & Greek parliamentary elections could usher in a new & serious phase of the European debt crisis

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  • IMF predicts the deepening economic recession in Spain will undermine their government's efforts to reduce its budget

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  • Recessions deepening across the European periphery & political uncertainty growing in European countries

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While markets are again correctly obsessing over Italy and Spain’s poor economic growth prospects, as reflected in markedly higher government bond yields for those two countries, they seem to have taken their eye off two upcoming political events that could usher in a new and more serious phase of the European debt crisis. The first is the French presidential election, the first round of which was scheduled for last Sunday, and the second round for two weeks later. The second is the Greek parliamentary election on May 6, which could result in the formation of the weakest of Greek governments.

"The IMF now expects that the severe budget austerity being undertaken in both of those countries will result in their GDP declining by close to 2 percent in 2012." -- Desmond Lachman

This week, the IMF revised its economic forecasts for Italy and Spain in a manner that will only heighten the market’s deep concern about those two countries’ prospects of restoring long-run fiscal sustainability. In its revised World Economic Outlook, the IMF now expects that the severe budget austerity being undertaken in both of those countries will result in their GDP declining by close to 2 percent in 2012. Worse still, the IMF is predicting that a deepening economic recession in Spain will undermine the Spanish government’s efforts to reduce its budget deficit, which the IMF expects to remain at around 6 percent of GDP in both 2012 and 2013. Similarly, the IMF believes that a weaker Italian economy will prevent that country from stabilizing its public debt-to-GDP ratio, which the IMF now forecasts to rise to 124 percent of GDP by 2013.

Against this gloomy economic backdrop for Europe’s third- and fourth-largest economies, the last thing that the European debt crisis now needs is destabilizing political events. Yet that is what is all too likely to occur in both France and Greece within the next few weeks. In France, the Socialist Party’s Francois Hollande is consolidating his commanding lead in the polls against the incumbent Nicolas Sarkozy in an almost certain second round run-off between those two candidates. Meanwhile in Greece, the polls are suggesting that the New Democratic Party and PASOK, which form the current ruling coalition, will be lucky to retain the slenderest of majorities in a newly elected Greek parliament. At the same time, the political parties of the hard Left will garner almost as many votes as their centrist rivals, while the number of political parties represented in the Greek parliament could rise from its present five to nine, as parties on the extreme Right and extreme Left exceed the 3 percent minimum threshold for parliamentary representation.

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Desmond Lachman is a resident fellow at AEI.

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