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Could the euro zone periphery head off the rails again?

Almost a decade on from the sovereign debt crisis, we explore whether the euro zone’s peripheral economies have materially improved or old vulnerabilities will again become apparent as growth slows.

7 minute read

storm over the parthenon

The sovereign debt crisis that began in Greece in late 2009 and spread swiftly to other peripheral euro zone economies tested the region’s policymakers to its limits. But bailouts for Greece, Ireland, Portugal, Spain and Cyprus, combined with a ‘whatever it takes’ promise by the European Central Bank (ECB), restored calm. 

Progress since then across peripheral economies, unkindly labelled the PIIGS (Portugal, Ireland, Italy, Greece and Spain), has been uneven. Although GDP per capita is now higher in Portugal, Ireland and Spain, it remains well below pre-crisis levels in Italy and Greece; where the jobless rate also remains much higher, as well as in Spain.

“The PIIGS label is misleading,” explains Stewart Robertson, senior UK and European economist at Aviva Investors. “While all peripheral countries were impacted by the sovereign debt crisis, the structure of their economies, policy responses to the crisis and their recoveries from it have varied significantly.”

But with growth in the euro zone beginning to slow down, the question remains: are peripheral economies better equipped to survive another crisis or have the ECB’s extraordinary support measures masked fundamental weaknesses?

Mixed report

Ireland has enjoyed the strongest recovery among the peripheral economies, with robust growth leading to a rapid reduction in unemployment and improvement in public and private balance sheets.1 &2

“Ireland took comprehensive and early steps to get its economy back on track and restore its competitiveness, including reform of its banking sector,” says Robertson. “Keeping an open policy to trade and foreign investment, a key factor behind its rise in the 1990s and 2000s, has been central to its recovery.”  

Spain has also posted decent growth, reflecting “relatively light-handed fiscal adjustment, the effects of thorough reforms to the labour market and financial sector in 2012-13, and very favourable cyclical factors”, according to Peter Ceretti and Alfonso Velasco, analysts at the Economist Intelligence Unit (EIU).

However, unemployment remains a serious problem, especially among the young, and the share of temporary contracts and involuntary part-time employment remain some of the highest in the EU. Additionally, public debt has declined only marginally from its peak in 2014.3

Economic conditions have improved in Portugal, which has recorded one of the fastest declines in unemployment among OECD countries over the past five years.4 The economy has also rebalanced to become more export-oriented, moving the external current account from a chronic deficit of around ten per cent of GDP to a balanced position, according to the IMF which also praised Portugal’s “impressive progress” in cutting its fiscal deficit. 5 However, the poverty rate of the working age population remains elevated.

Progress has been less evident in Italy and Greece, which are the only European Union (EU) countries where output has failed to recover to pre-crisis levels.6

Italian GDP per capita is lower, adjusted for inflation, than in 2000, and the economy slipped back into recession for the third time in ten years in the second half of 2018. The government says the contraction will continue this year, which will aggravate its financial problems. Italy has the highest level of government debt in the EU at more than €2.3 trillion.7

In contrast to the other PIIGS economies, Italy did not require a bailout a decade ago, but – with the exception of Greece – its problems have proven to be deeper rooted and more difficult to recover from.

“Until the recent agreement on its budget with the European Commission, Italy’s public finances were at risk of heading down an explosive and hugely unsustainable path,” says Robertson. “But there are still weaknesses in the Italian financial sector, and political tensions could flare up again. It is not out of the woods yet.”

Meanwhile, the Greek economy could take another decade to return to pre-crisis levels, according to government forecasts.8 General government debt is officially projected to reach €335 billion by the end of the year, around 185 per cent of GDP, according to EIU estimates. It is also almost entirely owed to official creditors (the EU and the IMF), so another debt writedown, as happened in 2012, is unlikely, says Agathe Demarais, principal economist at the EIU.

Missed opportunity?

The World Economic Forum’s Global Competitiveness rankings show that all the PIIGS have improved their position since the sovereign debt crisis.

Julien Rolland, European rates portfolio manager at Aviva Investors, believes this shows the benefit of structural reforms, particularly in Ireland and Spain. “Thanks to these reforms, actual and potential growth has improved, with Spain and Ireland posting some outstanding numbers, while public-sector deficits in most are also falling,” he says.

Despite this, Ireland is the only one of the PIIGS ahead of Malaysia, while Greece languishes behind the Philippines, Indonesia and Russia.

Italy, meanwhile, has wasted “much of the breathing room quantitative easing bought for the sovereign, and very little has been done in terms of structural reforms since 2015,” according to Ceretti and Agnese Ortolani, another analyst at the EIU. There have been some changes to the labour market, as well as partial reforms to the financial sector and the public administration, but these have been diluted by persistent political strife.

Political issues have also hit Spain. The country experienced two inconclusive general elections in 2015-16, and much of the policy-making capacity of the then minority Rajoy government was absorbed in managing the Catalan crisis of 2017 rather than implementing pro-growth reforms. The current Socialist Workers' Party minority government is numerically even weaker, and its failure to pass its 2019 budget proposal resulted in the calling of yet another general election, scheduled for 28 April. Rolland agrees “broken trust between part of the electorate and the political elites” has put the brakes on further reforms.

High debt/low growth

While debt levels remain high in many peripheral economies, borrowing costs look to be manageable for the time being. Although its asset purchasing programme ended in December 2018, the ECB will continue to hold a sizeable proportion of government bonds as it reinvests the proceeds from maturing debt.

Ireland is well placed for now, with the solid rebound in economic activity and substantially lower interest payments helping to restore the government’s financial position. Nevertheless, public debt is still comparatively high – particularly for a modestly sized economy – at just over €200 billion.  A slowdown in growth due to headwinds in the global economy and the fallout from Brexit are other potential risks.

Greece, meanwhile, has exceeded its annual primary surplus targets, but at the expense of economic growth. Meeting such targets will remain a constraint on growth, alongside other negative factors, such as poor demographics and a weak business environment.

As the ECB winds back on QE, yields in Spain and Italy could come under pressure, although there would be more volatility in Italian markets as a likely result of concerns over the policies implemented by the current administration. Given Spain’s debt levels, the new government that takes power after the April election will need to remain cautious about its policy stance – particularly as growth is likely to slow to a very meagre 0.4 per cent in real terms in 2019, according to the EIU.

While Italy’s woes are well known, there are no easy fixes. “Italy has had a low growth problem going back decades, but somehow managed to deal with it. In the past, that typically included devaluation of its currency. As it no longer has that option, the low growth issue has been more pervasive. Many would argue that this contributed towards the growing disenchantment of elements of the population,” says Robertson.

“Second, Italy has much higher public debt than most. This means any deviation from a “prudent” fiscal path can lead to explosive outcomes,” he adds. “The two are linked by the debt-deficit dynamics algebra, which connects debt ratios with interest rates and GDP growth rates. Low growth and high debt is a tricky combination. Recently the Italian government had to assume unrealistic GDP growth rates to get their budget plans through. They have since adapted but may well have to do more – the problem therefore simmers away dangerously and could erupt if another slowdown materialises.”

As the ECB winds back its support, borrowing costs in Portugal will also come under upward pressure, says Demarais. However, she believes the impact will be limited, since it will be “partly offset by the more liquid demand for Portugal debt that results from the upgrade to investment-grade level of Portugal’s credit rating”.

The reforms Portugal implemented in return for its bailout, particularly in the labour market and on the external adjustment front, means the economy is better placed to deal with a recession than it was some years ago.

Nevertheless, the level of indebtedness of the country and the state of the Portuguese financial sector mean a potential global recession could have a stronger effect on the economy than in other countries, as credit channels could become impaired, warns Demarais.

Bound to the euro project

Peripheral may be an accurate geographic description but economically it is a misnomer. The aggregate GDP of these euro zone economies amounts to around US$4 trillion, equivalent to the fourth largest economy in the world and bigger than Germany.10

Yet, despite having made progress since the debt crisis, each of the PIIGS faces its own unique challenges. And while they may be able to weather a short and shallow downturn, a prolonged recession could prove damaging economically and politically. The ECB pledge in March to provide cheap funding to ensure credit keeps flowing to companies and households came with an expectation that governments to do more to support growth via structural reforms and fiscal policy.11

“So long as the European project remains incomplete – banking union, closer fiscal and political integration – there will always be the danger of episodes like the stand-off between Italy and the European Commission,” says Robertson. “And although we are not projecting a nasty downturn or recession in the next few years, at some stage one will materialise. If the euro zone does not have solid and coherent institutional infrastructure by that time, the risk of another damaging threat to European unity could yet emerge.”

Ultimately, the fortunes of the PIIGS are bound to decisions that will shape the future of the broader euro zone.


  1. OECD Survey’ OECD, March 2018
  2. Ireland’s rapid economic growth’, IMF, June 2018
  3.  ‘Spain makes up ground’, IMF, November 2018
  4. OECD Survey’, OECD, February 2019
  5. Portugal’s impressive progress’, IMF, March 2019
  6. Italy and Greece still struggling’, Financial Times, November 2018
  7.  Italy slips back into recession,’ BBC News, January 2019
  8. ’10 more years for Greece’, Ekathimerini, February 2019
  9.  ‘Euro zone’s slowdown’, Reuters, 31 January 2019
  10. World’s largest economies’, Trading Economics, March 2019
  11. ECB urges greater government action’ Bloomberg, March 2019


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