Escaping Japanification Difficult for Eurozone If It Takes Root


Saturday, November 30, 2019 / 06:21AM / Fitch Ratings / Header Image Credit: Business Standard


The eurozone has some of the symptoms of 'Japanification', but not the full-blown condition, Fitch Ratings says in a new report. Critically, it has avoided outright price deflation - a key element of the experience in Japan. However, if Japanification were to become entrenched, it would leave the eurozone more vulnerable to pernicious debt deflation, prolonged stagnation, rapidly rising government debt ratios and sovereign rating downgrades. Meanwhile, policymakers would have limited ammunition to counter the next downturn.


The eurozone's persistent low inflation, lacklustre growth, negative interest rates and difficulty of exiting from quantitative easing (QE) suggests that succumbing to the malaise of Japanification is a genuine risk. An ageing demographic profile, weak banks and private-sector deleveraging following the global financial and eurozone crises, which were preceded by credit and asset price bubbles, add to the parallels with Japan.


The 19 eurozone states have very different recent economic performance, potential growth rates, demographic trends, debt levels, banking systems and economic flexibility. Our heat-map looked at 18 macroeconomic, debt, banking sector, demographic and structural indicators to gauge each country's symptoms of Japanification. Greece, Italy and Portugal are most at risk.


"Heterogeneity within the eurozone, limits on fiscal and monetary policy, and strains on political cohesion mean that it would be impossible for the eurozone to replicate the extent of monetary and fiscal effort that has been required to lift Japan out of deflation, if it were to take root. Abenomics simply could not happen there," says Ed Parker, Managing Director in Fitch's Sovereign team


"We will never know what GDP growth and inflation would have been in Japan without such a large fiscal and monetary stimulus, but presumably much lower. This underlines the importance of using available policy space to prevent Japanification taking root in the first place," Parker adds.


Persistent divergence of economic performance would amplify the strains on 'one-size-fits-all' monetary policy. It would be politically challenging for the European Central Bank (ECB) to lift its 33% ownership limits on sovereign debt, and highly unlikely it could expand its balance sheet to the extent of the Bank of Japan. Growing dissension in the ECB Governing Council highlights tensions among countries.


The EU's Stability and Growth Pact and market confidence would not allow eurozone members to run budget deficits or increase government debt to levels seen in Japan. Those at greater risk of Japanification have less fiscal space to deploy. Those with greater fiscal space, including Germany and the 'Hanseatic League' of northern countries, have traditionally been the most ardent advocates of maintaining a tight fiscal stance.


The euro remains generally popular. Populist parties such as Lega and Five Star in Italy and National Rally in France have moved away from overt opposition to the single currency. Nevertheless, political cohesion among 19 countries will naturally be lower than in one homogenous nation state such as Japan.


The eurozone survived the severe stress test of the eurozone crisis intact, and has since made some progress with reforms to strengthen its institutional underpinning to make it a more resilient single-currency area. Fitch does not expect any country to leave the eurozone.


Fitch does not expect outright price deflation and prolonged economic stagnation in the eurozone. However, in that event, with few obvious policy alternatives and fraying political cohesion, calls for eurozone exits could resurface.


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