Surprise results could increase treasury challenges.
The British vote to exit the European Union (EU), referred to as Brexit, has so far had little impact on the UK economy or stocks, but an important string of European elections this year may reveal whether it was the first step toward a much bigger break up.
A year ago, few would have thought the break up of the EU even remotely likely. However, the Brexit vote and President Donald Trump’s election win changed all that. Elections this year in especially France but also the Netherlands, Germany, the Czech Republic, and perhaps Italy could set the EU on a path that would challenge corporate treasury departments for years to come.
The Brexit impact was a popular topic at NeuGroup meetings last fall, and this year’s European elections will be key events for corporates to monitor, as more unanticipated wins could signal a sort of snowballing of events leading to a larger breakup.
“Our number one area of concern for investors and finance executives would be another challenge to the reasoning behind the EU,” said Michael Thompson, managing director and chairman at S&P Investment Advisory Services, an asset allocation strategist and equity advisor.
Mr. Thompson said Brexit has pushed events that may have seemed very unlikely much further into the realm of possibility. Should someone be elected who schedules the country to have a referendum over staying in the EU, and there’s another vote to leave, “The question becomes: What is the survivability then of the EU?” Mr. Thompson said, noting that should another country leave, it lowers the barrier for other countries to exit that much further.
That’s especially true if a major EU economy such as France votes to leave, and it will provide an early test. Its first round of presidential elections are scheduled for April 23, and the second for May 7. Among the four candidates vying for the presidency, the National Front’s Marine Le Pen has been gaining ground and in a February 22 poll stands to win the first round of voting, although not the presidency. Le Pen has called for a national referendum on whether to remain in the EU, so a surprise win could significantly stress markets.
Marie Albert, deputy head of international diagnosis and forecasts at Coface, which insures companies against the risk of clients defaulting, said political risk is a crucial issue impacting economic growth. Coface has sought to compute the impact of major political shocks, she said, and determined that an extreme party such as Le Pen’s winning the election would have a 0.7% negative impact on France’s economic growth after one year. “We look in the past at how GDP reacted to political uncertainty and try to estimate what that impact could be in the future,” she said, adding that Coface anticipates France growing at 1.3% in 2017, so a Le Pen victory could cut that growth by more than half.
Coface forecasts business insolvencies in France to decline by 1% this year under the 1.3% growth rate, and a 0.7% plunge in growth would instead increase the insolvencies by 1.1%, Ms. Albert said. Among the European elections slated for this year, France’s is the “grandaddy,” Mr. Thompson added, and should the election result in a referendum over whether to stay in the EU, events could quickly unfold.
“A French referendum that has an outcome like the UK’s would imperil the EU. Most CEOs and market participants would fee the EU has become fundamentally different,” Mr. Thompson said. “It’s a bit like dominoes—you have alliances that appear to be infallible, and all of a sudden there’s a complete change. That’s something markets will have to figure out how to deal with.”
The treasurer of a Fortune 500 company noted recently at a NeuGroup meeting that the EU was originally conceived as a mechanism to keep France and German out of war, but in the decades since has focused on the benefits of trade and a common currency. As its original mandate erodes, the lack of a fiscal union makes a common currency ever more challenging.
Members of Germany’s federal parliament, the Bundestag, face elections September 24. Coface views those elections as posing less risk than France’s, partly because Chancellor Angela Merkel, who also heads up the Christian Democratic Union, retains significant support
“The German population’s feelings about immigration are quite different than [those of the French and many other Europeans] because German’s economic situation is more favorable,” Ms. Albert said.
An early warning for what’s to come for Europe’s biggest economies may be the Netherlands’ general elections March 15, to elect all 150 members of the House of Representatives. The leader of Holland’s far-right Freedom Party, Geert Wilders, has publicly supported leaving the EU, pointing to the UK as an example of regaining sovereignty. Mr. Wilders has taken the lead in the polls but is generally viewed as unlikely to become prime minister because of other parties’ reluctance to join his coalition. Nevertheless, he could hold an influential role in the next government.
Ms. Albert said that if the unexpected should happen, and Wilders captures the prime minister seat, it would not result in the same economic shock as France or Germany, if because of Holland’s smaller economy. “The Netherlands is an important country in Europe, but it’s not an important destination for exports, although 7% of goods in France do come from there,” she said.
The Czech Republic, smaller still, provides a similar story. All 200 members of its Chamber of Deputies will be up for election in October, and the resulting government will choose a leader. A bigger story may be Italy, which has been in the economic doldrums for years but still ranks 9th in the world in terms of GDP. Its highest court recently ordered limited changes to a controversial new electoral law, perhaps permitting early national elections as soon as June. An Italian vote on constitutional reform in December swung heavily in favor of populists, prompting Prime Minister Matteo Renzi to resign.
Another risk for corporate finance executives to monitor is Greece, which continues to teeter economically and financially. Coface is less worried about it than a few years ago, Ms. Albert said, because while the political situation remains fragile, GDP is expected to increase to 1.4% this year, from 0.3% last year.
She said another risk in Europe is increasing inflation, now at 1.1% in the Euro area, stemming largely from the increasing pricing of oil. In the UK, Coface forecasts inflation reaching as high as 2.5%, stemming mostly from the depreciation of pound sterling. In recent years, the threat of deflation has been a bigger concern across Europe, and while inflation isn’t expected to jump significantly, it still could weigh on buying power.
Higher inflation “would not be catastrophic, but inflation will weigh on growth for European developed countries,” Ms. Albert said.