MNI INTERVIEW: Eurozone Needs Private Debts Wiped-WIIW Chief

Deflation is still a threat to the eurozone, the head of a leading Austrian think tank told MNI, adding that his country's service sector faces "devastation" once emergency support measures are withdrawn and that private debts may have to be cancelled across the European Union.

Supply-side problems driving a rise in prices are not being matched by higher wages or fuel costs and could ease in months, Mario Holzner, executive director of the Vienna Institute for International Economic Studies (WIIW) said an interview, warning that eurozone jobs sustained by public aid could soon be lost amid a wave of insolvencies.

"I think we still have to fear deflation more than inflation in the medium term," Holzner said in an interview.

Next year will bring a wave of balance sheet problems for Austrian and European companies of all sizes, he predicted, with Austria's service sector facing "devastation" once emergency liquidity measures are withdrawn.

AID TO COMPANIES

The European Union should broker a solution to provide companies with medium-to-long-term loans to companies, convertible into shares in the event of default, he said, referring to a potential scheme along the lines of proposals by the Association for Financial Markets in Europe. If the EU does not act, member states will enact their own programmes, he said.

"Then the rich countries will manage and others will just have bigger problems than before."

Some private debt cancellation will be required, Holzner said, in addition to the creation of a bad bank or bad company, with costs to be spread across the business sector.

Kick-starting Europe's economy will require large-scale public investment in infrastructure, public transport, and in green industry and energy. Failure to do so by Europe would risk falling behind the U.S. and China, he added.

Given these needs for funds, signs of a paradigm shift away from fiscal conservatism are welcome, he said. But there is a danger political changes, such as a shift to the economic right in Germany following September's federal elections, could prompt a tightening in fiscal policy across the EU. Fiscally frugal states may also resist needed changes such as a reform to the rules on public debt included in the EU's Stability and Growth Pact, he said.

LOOSE ECB POLICY

Any shortfall in Europe's public spending response may require even looser monetary policy from the European Central Bank, which is likely to have to continue its pandemic emergency purchase programme beyond its currently planned horizon, even if the PEPP has to be repackaged to quell objections from monetary hawks. The ECB may have to keep policy settings very loose for at least seven years, Holzner said, "particularly if fiscal policy is not able to do more than they are doing now."

Europe's medium-to-long-term challenges are compounded by inevitable structural economic changes derived from shifting environmental priorities, particularly for car-manufacturing giant Germany and the countries linked into its industrial cluster, such as the Czech Republic, Slovakia, Hungary, Poland and Slovenia.

"This whole carbon-based industry is very strong, and so this ongoing structural change will have some sorts of repercussions for central and eastern Europe for sure, that is clear, and the shift to a more human capital-based economy will be very difficult," Holzner said, while noting that car industry expertise extended beyond technology used in internal combustion motors.

In Austria, a recovery in tourism could leave growth better than expected this year, following last year's contraction in output of 8-10%, he said. But insolvencies and other headwinds could soon push the economy back towards deflation after the initial rebound. Holzner is also becoming less optimistic about an early resolution of the health crisis, which he had hoped would be resolved by September, but which he now thinks could drag on for as long as until next summer.