Reforms have strengthened the European Union (EU) in recent years, but the economic bloc remains vulnerable to any future shocks, leaving governments and other issuers of debt exposed to negative credit implications, says Moody’s Investors Service.
In its report, entitled ‘European Union: Significant Political Change, Yet Economic Vulnerabilities Remain’, the credit ratings agency (CRA) notes that since the 2008-09 global financial crisis and the European sovereign debt crisis in 2012, the EU has made progress in strengthening its institutions, including the establishment of the European Stability Mechanism (ESM), the European Banking Authority (EBA) and other structures.
However, institutional reform and the euro area’s integration are unfinished and have left the EU exposed to shocks and downside credit risks.
“We have seen substantial institutional changes in Europe over recent years,” said Colin Ellis, Moody’s managing director, chief credit officer for Europe, the Middle East and Africa (EMEA), and co-author of the report. “However, as significant as these steps were in political and economic terms, great vulnerabilities remain in the euro area.”
For example, Europe’s banking union is incomplete, the ‘Juncker Plan’ to promote investment in Europe has run into difficulties and imbalances in public and private demand are not being addressed through fiscal policy because significant fiscal union is still off the table.
The European institutions also face challenge that extend beyond the economy and financial markets, suggests Moody’s. Years of austerity policies have fuelled resentment and disappointment with the EU project in some countries, while the EU’s fragmented response to the migration crisis has also exposed weaknesses in its decision-making process.
The 23 June UK referendum on its EU membership has created uncertainty. If the UK votes to leave the EU, it could fuel support for anti-EU parties elsewhere, weaken investor confidence in the bloc and lead to liquidity challenges for EU issuers.
While the EU has over the years displayed an ability to adapt and reach difficult compromises, the catalyst for change has often been a crisis, the report adds.
“If the EU survives its current challenges largely unscathed, even a ‘small’ future crisis could threaten the sustainability of current institutional frameworks, if it coincided with negative public sentiment and populist political developments,” says Ellis.
“Ultimately, any scenario that leads to even the partial break-up of the Union would have material negative credit implications, albeit ones that may take many years to crystallise.”
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