When will the crisis end?

Lucy Mair gets a fresh perspective on the state of Europe's economy from the head of Financial Markets Advisory at BlackRock
Asset management
Commercial awareness

Tales of Europe's economic woe rarely left the headlines last year, and there's little doubt that economic stagnation, political uncertainty and high unemployment will continue to plague the continent in 2013. But Coenraad Vrolijk, a managing director at leading asset management firm BlackRock and head of its Financial Markets Advisory (FMA) practice in EMEA, believes there's reason for cautious optimism as Europe enters its fourth year of crisis. "We will get out of this, but it's going to take a long time," he says.

What's the problem?

The euro has borne much of the blame for Europe's economic troubles, but finger-pointing at the eurozone is misunderstanding the problem, says Coenraad. "There is a euro component to the crisis, which is triggered by stories of Greece and Ireland. But, in reality, it's a global developed-market crisis." The US and Europe "share the fact that we've over-indebted and leveraged-up our economies", he says.

Since the start of the European crisis in 2010, decision-makers and central bankers have been busy treating the symptoms of the continent's economic sickness. They've prevented a 1929-style economic collapse through quantitative easing, government bond purchases and bailout funds, which have provided much-needed liquidity to the financial system. What they haven't done, however, is address the underlying cause of the condition: excess debt.

Instead of deleveraging - reducing the level of debt by paying back what's owed - Europe's leaders have only transferred debt from financial institutions to governments. Coenraad explains: "Bank debt-to-income ratios have dropped, but the government ones have gone up", and, as a result, the total debt-to-GDP ratio for each country "hasn't changed much since 2008".

The process of deleveraging would be politically and socially challenging, and there's no quick fix, but Coenraad is frank about the situation: "We have borrowed too much from ourselves... and now we've just got to pay it back, and paying it back means spending less. That's a painful message, but it's what it boils down to."

Can Greece recover?

The message is particularly painful for Greece, which owes around €360 billion (£292 billion) and is already struggling to deal with austerity measures imposed as a condition of its bailout. Although Greece is treated as a scapegoat for Europe's troubles, Coenraad says Greece "is just a distraction" rather than a real problem for Europe.

When Coenraad joined BlackRock in 2011, FMA was called in by the Bank of Greece to conduct stress tests on the Greek banking system so a bailout could be negotiated. He says: "The Greek banking system is not really the problem in Greece - the banks are victims of the overall indebtedness of the country," which stems from the government inflating wages without improving economic productivity, and overspending while allowing widespread tax evasion.

Austerity is difficult to come to terms with for Greeks rallying against wage cuts and job losses in Syntagma Square, but measures such as wage deflation are helping the country take steps towards recovery. Coenraad explains: "If wage levels drop by 20 per cent, the cost to manufacture anything also drops by 20 per cent," making Greek exports cheaper and more competitive with those produced elsewhere in the eurozone.

But the Greek government has done little to address its tax problem, which is holding back recovery and leaving Greece dependent on liquidity from the ECB for the foreseeable future. "The primary surplus in Greece is edging towards the balance, but it's being driven purely by austerity rather than tax collection, let alone tax increases. As far as I've seen, there's been no real improvement in the tax collection process," he says.

How do asset managers respond?

"When you're managing people's pension savings, the most important thing you can do is diversify so you don't become massively exposed to a single risk," says Coenraad. This means that exposure to Greek government debt by any one fund under management would be "microscopic". Although political and economic uncertainty makes Greece a risky investment, Coenraad says some fund managers are actively seeking opportunities in Greece and taking advantage of the low prices of assets.

What's more, taking a risk can pay off. BlackRock's 2013 Investment Outlook recommends investing in peripheral southern European economies Italy and Spain, rather than the so-called safe havens at the core of the eurozone, such as Germany. "The price of German bonds is so high, you get negative returns after cost. There is only downside over time in holding German debt," explains Coenraad. But for Spain and Italy, "it's unlikely the situation will get worse in the long term, and it's very likely to get better. As it gets better, yields will drop and prices will go up," meaning higher returns for investors.

For FMA in particular, the high volume of distressed assets means that the business is growing. "The deleveraging process is going to take a very long time, so the fact that there are lots of assets that don't perform will stay," says Coenraad. In addition, as a result of the widespread loss of trust in the financial system, stakeholders "increasingly appreciate the independent views" offered by the FMA business.

In it together

The debt crisis is extremely complicated and European leaders are tasked not only with finding a solution to the current problem, but also with preventing similar crises in the future. "There's no magic bullet here, and that's exactly what decision-makers are grappling with," says Coenraad. Still, although the ECB expects the economy to shrink overall in 2013, he's confident about Europe's longer-term prospects: "The most optimistic people would estimate recovery in three years, but there's broad consensus at around five years."

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