Letter from… Brussels: The ripple effects of the euro-zone crisis

Tony Barber, Europe editor, "Financial Times"The majority of European companies – and quite a few beyond – have been affected by the euro zone’s sovereign debt crisis, although the impact varies considerably from sector to sector and country to country. Numerous businesses in Germany, for example, report full order books and few problems in securing bank credit. Exporters are benefiting from the euro’s decline last year on foreign exchange markets, while healthy consumer demand, helped by rock-bottom interest rates, is helping sales at home.

But in Greece, business conditions are grimmer than at any time since the restoration of democracy in 1974. Greek executives complain that the foreign companies they do business with demand cash up front, while domestic clients delay payments for months on end. In both Athens and Thessaloniki, the nation’s major cities, companies are slashing investment, shedding staff and putting their remaining employees on reduced hours.

Probably the most comprehensive picture of how the debt crisis is affecting European companies appears in the detailed surveys on access to credit that the European Central Bank (ECB) publishes every six months. In its latest report, published in December, the ECB stated that, when asked to name their most pressing problems, small and medium-size companies in the euro zone put “finding customers” first, “access to finance” second and “availability of skilled staff or experienced managers” third. Significantly, access to finance was a more serious concern for SMEs than it was for large companies. Only 11% of large businesses described access to credit as their main difficulty, compared with 23% of SMEs.

The sovereign debt crisis has a direct impact on credit conditions because bank lending is the primary source of funds for European companies. Many banks feasted on government debt in the first 11 years of the euro’s life, from 1999 to 2010. In recent times, they have taken drastic action to repair their balance sheets and to meet stricter capital ratio requirements set by regulators. In some countries, including non-euro nations such as the UK, this shrinks the pool of credit available for smaller businesses.

Conditions should, in principle, have become easier with the ECB’s injection of massive amounts of liquidity into Europe’s distressed financial system. Banks gobbled up €489 billion (approximately $636 billion) in cheap three-year loans in December, and another €530 billion (approximately $712 billion) at the end of February. However, it remains unclear to what extent banks are redistributing these funds to businesses as loans, rather than merely bolstering their reserves or – as is happening in Italy and Spain – gorging once again on sovereign debt.

Some business sectors are suffering more than others from public expenditure cuts and other austerity measures introduced by governments in an attempt to put their fiscal houses in order. This is particularly true for pharmaceutical companies and suppliers of medical equipment in Greece and Italy. Companies are experiencing long delays in reimbursement for medicines and other products delivered to state-run health services.

By damaging consumer confidence, raising unemployment levels and depressing wages in many countries, the sovereign debt crisis is aggravating the long-standing structural difficulties of sectors such as the European car industry. Before the financial crisis began in 2008, experts estimated the production overcapacity in Europe’s passenger car market to be as high as 30%. Since then, car sales in Europe have declined every year.

This is the backdrop to the alliance announced in February between PSA Peugeot Citroën and General Motors, both of which lost hundreds of millions of euros last year in their European operations. Nevertheless, German producers such as Daimler and Volkswagen are well placed to survive Europe’s lean years. One of Volkswagen’s main strengths is that it sells about a quarter of all its cars in China. So as long as the Chinese economy continues to expand – it is expected to account this year for about half of global growth – Volkswagen will be in good health.

One remarkable feature of the euro-zone crisis is the repricing of risk between government and investment-grade corporate debt. Traditionally, sovereign debt was the safest place for an investor to park money. Now that the danger of default has reared its head, not only in Greece but potentially in a string of other Mediterranean countries, the bonds of some European companies are trading at yields below those of comparable government paper.

The duration of this phenomenon will depend, ultimately, on how effectively Europe’s political leaders tackle the debt crisis. The very least they must do is to remove the uncertainty over whether Greece has a future in the euro zone. If the answer is no, they must explain how they intend to stop financial contagion from destabilising the entire single-currency region.

By Tony Barber, Europe editor, "Financial Times"

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