Abheek Barua & Bidisha Ganguly: Darker days ahead for Europe

The continent remains a bagful of woes, as bigger economies teeter on the brink of a crisis. This could send shock waves across the markets

The joke in dealing rooms is that if life ever gets too dull, Greece is always there to provide some action. Indeed, the possibility of "Grexit" still remains, with the Greek government falling short of the rather stringent targets laid down by its principal lenders, the dreaded troika of the International Monetary Fund (IMF), the European Union and the European Central Bank. However, the continent's problems are not just about periodic flashpoints in Greece. Europe remains a bagful of woes and there are much bigger economies that are teetering on the brink of a crisis, which could send shock waves across the markets.

Take Italy that has induced a fresh round of jitters and in a sense represents all that is wrong with Europe and its economic policy. Going by a number of surveys it seems safe to conclude that economic activity is slowing down, as the boost from low prices fades and the commitment to austerity means that further fiscal stimulus will not be forthcoming. The influx of asylum seekers has already put a strain on expenses. There is also the threat of the European Commission (EC) imposing a fine for reneging on its fiscal commitments. (It is apparently also considering fines for Spain and Portugal for a similar lapse). Were this to happen, Italy might actually be forced to go in for a pretty massive fiscal compression that will take growth down sharply.

Add to this around $400 billion of bad loans that a prolonged recession has left in its wake for banks and the recipe for an economic crisis seems complete. Italy's bank shares have on average dropped by about 30 per cent since the beginning of the year. Banks and other financial institutions have put together a bailout fund rather inappropriately called Atlante (Atlas in Italian after the Greek god), given that its size is a piffling $5.5 billion. Efforts are on to streamline bankruptcy laws but the likelihood of a quick change in Italy's notoriously sclerotic legal system is somewhat low.

Did we mention the fact that there is a possibility of the incumbent government toppling on the back of a constitutional referendum due later this year? This could leave an economy like Spain (another problem child of eurozone) without a government for a while or usher in the stridently anti-austerity Five Star Movement to power.

But the fault does not lie in Europe's stars or in the imposed austerity. Countries remain resistant to the idea of structural reform, as is evident from the recent strikes in France that are crippling everything from sanitation work to its transport system as we write. The strikes are over the "El Khomri" labour reforms (after the current Labour Minister Myriam El Khomri). These attempt to make redundancies easier for firms in distress, reduce trade union power by allowing firms to call a vote of all workers over union demands, increase taxes on temporary contracts to encourage permanent employment and increase firms' flexibility over hours and pay if they are trying to expand into new sectors or markets. In Italy, too, labour market reforms to reduce job protection are facing resistance.

In a nutshell, Europe is turning into an economically dark continent. Struggling economies within the currency union are saddled with what many see as an overvalued euro, the insistence by the Germans and the IMF that financial support is conditional on greater austerity is prolonging recessionary and deflationary trends and major trading partners like China are hobbled. The pain of fiscal rectitude is encouraging fringe anti-austerity parties both on the left and right to gain political mileage. Entrenched interest groups like trade unions are opposed to structural change. Thus the odds are heavily stacked against Europe and one can only hope for its super-easy monetary policy to work at some point. The risk of events in Europe derailing financial markets at least temporarily is growing. Watch that space carefully.

Abheek Barua and Bidisha Ganguly are chief economists at HDFC Bank and CII, respectively