Eurozone defaults would knock 5% off growth, says PwC

Orderly defaults by the eurozone’s most indebted members could cause the region’s economy to shrink by 5% in the coming few years, research by PricewaterhouseCoopers (PwC) claims.

In the What next for the eurozone – Possible scenarios for 2012 report, the professional services provider outlines four potential outcomes for the eurozone debt crisis – orderly defaults, monetary expansion, a Greek exit or a new currency bloc.

According to PwC, the eurozone economy will be most damaged if a programme of voluntary defaults is agreed for the most indebted countries, as this would lead to “a contractionary debt spiral and a prolonged recession, lasting between two and three years”.

This scenario would likely drive down GDP by 3% in 2012, the research says, followed by a 1.5% contraction in 2013 and by 0.5% contraction in 2014. Growth of 1% and 2% would be seen in 2015 and 2016, respectively.

PwC adds that Greece being forced to leave the euro would also result in a recession. Growth would fall by about 0.5% in 2012, but would resume in the following year and reach 1.8% by 2016.

Monetary expansion, on the other hand, would allow the eurozone to avoid recession, with growth coming at between 1.5% and 2% a year between 2012 and 2014. However, inflation would most likely be above the 2% target for most of this period.

Yael Selfin, the head of macro-consulting and a director in PwC’s economics team, says that orderly defaults, a Greek exit or strong monetary expansion could highlight the UK’s status as a safe haven.

“Capital flows out of the eurozone and into the UK would cause sterling to appreciate against the euro. Borrowing costs may well be lower as investors purchase UK gilts in preference to risky eurozone bonds,” she says.

“However the UK’s principal trading partner is the eurozone which is the destination for around 50% of its exports. A relatively strong sterling and a recession in the eurozone would weigh down on the UK’s growth prospects.”

Looking at the possibility of a new currency bloc, which would see core nations remain in the eurozone with those on the periphery excluded, PwC forecasts very different outcomes for the two parties.

‘New euro’ members will avoid recession in 2012, with 0.25% growth. Expansion of 2.5% would be seen in both 2013 and 2014, followed by 2% growth in the next two years.

However, the excluded nations would see GDP fall by 5% in 2012 and by 2% the year after. Their economies would be stagnant in 2013, before growing by 2% and 3% in 2015 and 2016 repectively, the study predicts.

Selfin adds that the eurozone of 2012 is likely to be “very different to the one we know today”, no matter which outcome materialises. She also predicts the final resolution for the debt crisis is likely to emerge during the first quarter of 2012.

“Expect surprises next year. We are currently experiencing unprecedented levels of uncertainty in the eurozone,” Selfin concludes. “A harsh adjustment to a new fiscal reality will be unavoidable, regardless of the path politicians decide to follow.”

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