Article
Written by Kady Potter
Posted on 24/09/2014

Fitch predicts a ‘doom loop’ of European bad debt

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In a new report, global credit rating provider Fitch has cast a shadow over the issue of European bad debt. The agency predicts that debts and deflation could create an unending loop of economic woe. Where banks need bailing out by their respective governments, the increased debt makes the bank – and in turn, the country – even more economically unstable. Economists refer to this scenario as a ‘doom loop’, a term first used by the Bank of England in 2009.

 

The predictions reach as far forward as 2022, and for some countries such as the Netherlands and Italy the outlook is not promising.

Issues with inflation and growth

In countries where levels of economic growth and inflation fall below what’s needed, this may pile on the pressure for national banks and financial institutions.

The figures Fitch uses are within the realms of possibility. The projection puts inflation at -1 per cent next year and zero per cent from 2016 onwards. In example graphs, the deflation level begins to sharply deviate from the baseline – in Italy’s case, sending deflation soaring to over 150 per cent of the country’s GDP. 

A boom in unemployment

Fitch claims that, in the event of deflation, unemployment levels could rise to as much as 12 per cent – and stay there. The figure is more than double that seen in Japan when the bubble burst there almost two decades ago.

Would the ECB step in?

The European Central Bank (ECB) has shown a willingness to intervene and help Europe’s economies. It recently cut interest rates to encourage banks to increase lending.

However, Fitch is anticipating that the ECB would not move to act, saying that the bank’s “actions to date cannot be regarded as pre-emptive.” Any “misreading of the economic outlook” by the ECB could leave European countries to fend for themselves.

Can the loop be avoided?

The Fitch report demonstrates the issues that Europe could face, and does not confirm that any such scenario will definitely happen. It emphasises that deflation is the least likely course of events described. 

However, given the agency’s reputation and international clout, the prospects are realistic to the point that business finance managers should be concerned. Once a country is in the grip of such a ‘doom loop’, recovery may be decades away.