Euro bounce, fiscal balances in focus

The sharp overnight jump in the EUR/USD is likely to be strengthen the case for the European Central bank to step up stimulus when policymakers meet next in March. A strong currency combined with weak supply-side pressures pose a fresh threat to inflationary expectations, delaying the scope of meeting the 2% inflation target. 

ECB keeps the door open for further policy easing, fiscal developments have also played a cohesive role. In 2009-10 the zone-wide fiscal deficit has narrowed from a peak of -6% of GDP to -3% by 2013 and to -2.0% of GDP by 3Q last year. Primary deficit (excluding interest payments) has improved by a larger extent, turning modestly positive last year. Austerity measures by way of tax hikes, cutback in wasteful expenditure and paring of welfare payments have helped to contain spending, even as revenues took a hit from weak growth. 

Lower fiscal deficits meanwhile slowed the built-up in government debt levels, but weak/negative growth in the years since the global financial crisis prevented a decline in the aggregate debt levels. This saw government debt as a percentage of GDP rise from 67% in 2004-05 to 78% in 2009-10. The build-up in debt levels continued in the subsequent years (amidst recessionary conditions) peaking at 93% of GDP early last year, before inching down to 91.6% by 3Q15. 

The fiscal/debt metrics are on the mend at the zone-wide level, the improvement is not uniform across member countries. Amongst the core economies, Germany is close to registering a modest fiscal surplus last year, along with a sub-3% deficit reading for Italy. On the other hand, France and Spain are likely to stay above the -3% of GDP mark, exceeding the red-line drawn by the Stability and Growth Pact. Amongst the rest, Portugal's deficit remains above 4%, while on-going fiscal austerity in Greece is likely to lower its deficit to a shade below 4% last year. 

Growth is required for austerity to be succeed and by extension, deficits/ debts to narrow. In this respect, while fiscal math is on the mend in the currency bloc, recovery needs to take hold amongst the member countries to ensure the improvement is broad-based and driven by higher revenues rather than aggressive expenditure cuts.