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Abu Dhabi, UAEThursday 18 October 2018

Europe is vulnerable with limited room for recovery in next financial crisis 

Capacity to absorb shocks has diminished and the current sluggish economic growth will limit the recovery of many sectors, Moody's says

Corporations in Europe are more vulnerable to next financial crisis as their capacity to absorb shocks diminish. AFP
Corporations in Europe are more vulnerable to next financial crisis as their capacity to absorb shocks diminish. AFP

European companies are vulnerable if another financial crisis occurs as their capacity to absorb shocks have diminished and the current sluggish economic growth will limit the recovery of many sectors, according to a new report.

"While there have been some improvements since 2008, Europe remains vulnerable in economic terms as debt loads are higher, there are fewer tools to aid recovery, asset prices are peaking, political and regulatory risks are rising, and disruptive technologies are affecting more and more sectors," Paolo Leschiutta, a senior vice president at Moody's Investors Service said in report.

"Overall, the amount of wiggle room available to mitigate the impact of another downturn is shrinking."

Europe is facing headwinds as is struggles to keep the economic momentum going amid the rise of populist sentiment in Italy and elsewhere in the economic bloc. The downbeat mood was reflected in the markets earlier in the week, as fears stemming from the Italian government’s fiscal plans pushed the markets lower. The common currency dropped for a fifth day to the lowest level in three weeks and European stocks slumped as investors sought refuge in treasuries and bonds.

Moody’s said that despite banks and other issuers benefiting from “benign credit conditions” and the lenders having strengthened their balance sheets a decade on from the last downturn, Europe is still not ready to cope with another major stress the financial system.

Private debt levels have remained at a historically high level in the last decade, leaving many issuers more exposed should interest rates rise sharply and remain high. The already high and increasing public debt levels will also leave a number of European countries exposed to the next recession and the impact of costs associated with ageing populations, Moody’s noted.

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“Government and central bank actions taken to aid recovery from the last downturn have limited the options at their disposal to counter the next economic decline,” it added. “Economic growth will remain sluggish, limiting the speed of recovery following a recession.”

Consumers’ increasing household debt and weak savings rates make it more likely that consumer confidence will slump in the event of financial market turmoil. Such a development will be a negative factor for companies as it usually means middle- and lower-income consumers in particular cut back on discretionary spending on items like consumer durables and entertainment, according to the report.

The current elevated asset prices mean some assets and financial markets are at risk of a sudden correction if interest rates rise quickly, beyond market expectations. For corporates, high multiples and asset valuations increase mergers and acquisitions execution risks because companies overpaying for deals might find it harder to reduce debt.

Low growth and still high unemployment in some jurisdictions fuel economic insecurity, fostering anti-establishment movements, which could further rise in popularity if another crisis erupts. Even mainstream policymakers could intervene to withdraw previously assumed support or increase protectionism.

“Economic insecurity is high and anti-consensus movements abound, and if another crisis erupts there may be a temptation to try a more idiosyncratic, anti-establishment political solution,” Moody’s said.