Southern Europe is Climbing Out of Debt


The boom period in Southern Europe was marked by large current account deficits and corresponding capital inflows. The crisis led to significant private capital outflows (Merler and Pisani-Ferry 2012), which stabilized around the middle of 2012 as documented in an earlier post. The crisis did not, however, lead to a sudden reversal in total capital inflows to Southern Europe because the decline in private inflows was coupled with an offsetting increase in liquidity provided by the Eurosystem (as recorded in Target2, the payment system overseen by the ECB) and official program money (for Greece, Ireland and Portugal). This post is an update on the current account developments in Southern Europe and the composition of corresponding financial flows.

Figure 1 plots the evolution of the current account in the crisis countries. On a seasonally adjusted basis, Ireland reached surplus already in the first quarter of 2010. The other four countries reduced their average current account deficit from -6 percent of GDP in 2011 to -1.7 percent in 2012. As documented by Guntram Wolff, the adjustment since the crisis has come to a significant extent from increased exports. This is true for all countries except Greece, where the declining deficit is almost exclusively due to import compression. Concerning the most recent data, Spain exhibited a positive current account balance in both Q4 2012 and Q1 2013 on a seasonally adjusted basis. The balance also turned positive for Italy and Portugal in Q4 2012 and Q1 2013, respectively.

Figure 1: Current account balance (%/GDP) 2006Q1-2013Q1, seasonally adjusted.

Declining current account deficits have halted the increase in total capital inflows to Southern Europe, which were negative for Portugal and Spain in the first three months of 2013. This relative inertia, however, masks changes in the composition of capital flows. A decline in Target2 liabilities has partly been offset by continuing public disbursements relating to adjustment programs (Greece, Ireland and Portugal) or bank recapitalization (Spain). This offset has not been perfect, though, as manifested by the return of private inflows particularly in Greece, Italy and Spain during the first three months of 2013. To the extent that Target2 credit has been replaced by private inflows, this represents a normalization of financing conditions.

Financial account data is released with a lag and therefore we are not able to comment on the evolution of capital flows in the second quarter of 2013. However, Target2 data is available until April 2013 for most countries and May 2013 for Italy and Spain, among others. In April, Target2 net liabilities increased in Greece, Portugal and Ireland by €12 billion in total after having generally declined in previous months. This was coupled with an increase of €19 billion in claims by Germany after five months of declines. Aside regular variation, this might reflect wobbles in the euro area macroeconomic outlook leading investors to shun small vulnerable economies. Nevertheless, Italy and Spain continued to decrease their Target2 liabilities (by a total of €8.4 billion in April and €17.6 billion in May). What is more, Germany’s Target2 claims decreased again by €18.7 billion in May, close to March levels.

Southern countries achieving external balance means that (as a whole) the economies are becoming no longer reliant on foreign financing. Before sectoral problems such as distressed banking systems or indebted sovereigns are overcome, however, Southern Europe will partly rely on official liquidity from abroad.


This is an edited version of a post that originally appeared on the Breugel blog.

Erkki Vihriala is a research assistant at Breugel. He holds an MSc Economics from the London School of Economics in addition to a Bachelor’s degree from the University of Helsinki. Prior to joining Bruegel, Erkki worked as an intern at the Bank of Finland. His core interests include empirical macroeconomics, monetary economics and financial economics.

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