The emergence of a new and seemingly more infectious strain of Covid-19 arrives at a difficult time for European countries, already saddled with debts, battling inflation and reimposing prevention measures during the winter months.
It is now barely a week since South Africa reported a new variant of Covid-19 (called Omicron), found to be proliferating among a relatively young population, which has also popped up in other countries to put authorities in a spin.
The combination of a strain that is seemingly more infectious than the Delta variant, and that might also evade current vaccines, has naturally sparked financial markets volatility.
This is regardless of the fact it might also be no deadlier than other mutations, existing vaccines could provide at least some protection against it, and manufacturers have indicated that they can tweak them to be more responsive, even if that may be weeks away.
Even so, there are no assurances that these measures will keep pace with infections. The situation is troubling for European countries, with several of them already struggling with higher Delta case numbers and reimposing restrictions for the winter when healthcare systems are also burdened by flu complications and other illnesses.
The economic implications are limited at present, as Peter Dixon, an independent expert and former financial economist at Commerzbank, notes with regards to Germany.
However, concerns about rising infection rates, the tightening of restrictions and the prospect that German federal and regional governments will vote for further restrictions of movement and a limit on numbers in public gatherings suggest that there are risks to fragile economic sentiment.
“The Blavatnik index of Covid-related restrictions in Germany has spiked to its highest since March, and in contrast to most other countries the degree of tightening is much sharper. This raises risks to the near-term German growth outlook,” says Dixon.
Vanja Piljak, a Euromoney risk panel expert and lecturer in finance at the University of Vaasa, notes that Covid restrictions have been tightened recently in Finland, too, in response to the deteriorating epidemiological situation there, evinced by a sharp increase in cases and hospitalization rates.
“The critical point for tightening restrictions was the limited capacity of intensive care units (ICUs), as evident in the statement of the minister of family affairs and social services, Krista Kiuru, who announced at a government press conference that on November 25 there was only a single ICU bed available for Covid-19 patients.”
The impact of the new strain is devilishly difficult to quantify. Simply put, there is just so much that is unknown. Most risk experts have said that it is too early to know with any reliability how it will impact on the real economy and government finances, or for that matter any other risk factors, be they economic, political or structural.
Nordic country expert Stein Gjerding, chief economist at Arbeidsgiverforeningen Spekter, says the highest risk for Nordic economies is a general fall in global activity with less concern for inflation in these countries and with sovereign creditworthiness little affected.
Euromoney’s risk survey contributors were already accounting for the various uncertainties surrounding Covid-19 – with restrictions tightened in certain countries to combat the Delta variant, and inflation taking off in many, there are some downgraded scores for specific factors, which may of course worsen if Omicron turns into a bigger problem.
Scores for Austria, France, Germany and Italy have all been downgraded along with a few other countries.
As country risk expert Norbert Gaillard of NG Consulting explains: “Since November 1, Covid restrictions have remained especially stringent in Italy, more moderate in France, and quite loose in Spain and the UK.
“In contrast, Germany has considerably tightened its lockdown policy, one of the strictest in Europe. Germany's move will affect GDP growth in the short term. However, by January 2022, Covid restrictions are likely to harden in France, Italy, Spain and the UK.”
Gjerding says that, in Denmark, Finland, Iceland, Norway and Sweden, stricter entry rules have been imposed due to the Omicron variant, and that PCR tests are mandatory for travellers from southern Africa, including quarantine.
“Testing in general and the use of face masks and Covid certificates has increased. However, all countries are far from a lockdown situation. The strongest restrictions are in Denmark, but all countries have so far a ‘business as usual’ approach,” he says.
Piljak says that it is premature to judge how the Omicron variant will affect the economic outlook, government finances and sovereign creditworthiness of countries in Europe, in reference both to Finland and countries in Central and Eastern Europe such as Serbia, which she follows closely. For now her scores are unchanged.
“If the vaccine shows up to be efficient, then the new variant will probably have only short-term negative effects. However, the constant uncertainty surrounding the future trajectory of the pandemic might also have long-term negative effects on the economic outlook, government finances, and potentially sovereign creditworthiness.”
Gaillard goes on to say that, although understanding the level of severity of the Omicron variant will take a few weeks, Moderna’s CEO has said that current vaccines will be less effective against this new threat.
The constant uncertainty surrounding the future trajectory of the pandemic might also have long-term negative effects on the economic outlook- Vanja Piljak
“As a result, if the Omicron variant spreads in Europe, we may expect a serious sanitary crisis with economic implications.
“For the moment, I do not think this is the most likely scenario. Yet, the moderate risks associated with the limited spread of the Omicron variant are now factored into the scores of my countries.”
Gaillard says the assumed limited spread of the Omicron variant and the resurgence of the Delta variant pandemic, and their expected consequences in terms of lockdown stringency, have affected three factors in particular: the economic-GNP outlook, government stability and soft infrastructure.
However, he also points out that if the Omicron variant turns out to be more dangerous and transmissible than the Delta variant, then additional factors would be affected, such as employment/unemployment, government finances and institutional risk.
Risk panel expert Constantin Gurdgiev, associate professor of finance, Monfort College of Business, University of Northern Colorado, says that subject to careful monitoring of the evolution of the new virus variant, it is warranted to take a more sceptical look at forecasts for economic growth, employment, financial system stability and political stability in the majority of European countries.
“The greatest negative impact to the forecasts can be expected in larger, more domestic economy-dependent states, such as France, Germany, Spain and Italy,” he says.
“Mediterranean states heavily dependent on winter tourism from the rest of Europe, such as Greece and Cyprus, will also see significant spillovers from travel restrictions that can come into play if Omicron proves to be more contagious and/or perilous than Delta.”
Cyprus is certainly one of the countries with a moderately deteriorating risk score.
This leads to a very tricky and complex issue concerning sovereign creditworthiness.
“First, the capacity of European governments to support and bail out distressed banks and firms is not boundless,” Gaillard warns.
A major sanitary crisis could trigger a recession and dramatically undermine the credit position of a country, he says, with Spain and Italy appearing to be vulnerable.
“Second, the Bank of England and European Central Bank are between the devil and the deep blue sea.
“On the one hand, they may have to stimulate economic activity through increasingly accommodative monetary policies. This option is likely to weaken the credibility of pound sterling and/or the euro, which would eventually jeopardize access to capital markets.
“On the other hand, central banks will have to act against present inflationary pressures, otherwise they will lose credibility in the eyes of foreign investors. This option could depress economic activity.”
His view is that British and European policymakers will have to accept a spike in corporate default rates (especially among zombie firms) to preserve monetary credibility and political stability.
Gurdgiev notes that across the EU and broader European continent, there is a growing wave of public disappointment with the continuously volatile policy responses to the Covid-19 pandemic.
At the same time, there is strong public dissatisfaction with the lags in policy responses to the Delta variant.
“The recent wave of the pandemic associated with the Delta variant, while abating, is currently fuelling a rapid decline in public approval ratings of a number of governments and political leaders,” Gurdgiev says.
“Thus, as the Omicron variant enters the forecasting scenarios, we are witnessing simultaneous increases in the uncertainty of economic and public safety policies responses across several dimensions.”
The strength of public discontent with restrictions is likely to have a severely adverse effect on the economic recovery- Constantin Gurdgiev
The first dimension he refers to relates to the high levels of public discontent with existent elevated restrictions on public mobility and socializing.
“This discontent is likely to result in the lower effectiveness of any public health measures that policymakers and authorities may plan, or are currently putting in place, leading to potentially a more severe spike in new cases, hospitalizations and deaths in the weeks ahead, should Omicron prove to be a significant player globally.
“The strength of public discontent with restrictions is likely to have a severely adverse effect on the economic recovery and financial systems stability in Q1 2022 and beyond.”
The second dimension is public disillusionment with the effectiveness and deployment of public health measures associated with prior waves of the pandemic, which is likely to push many governments and public authorities to attempt more proactive and aggressive early-stage responses to Omicron.
“These responses are already visible globally in the form of swift and relatively strict constraints on some international travel, as well as introduction of curfews, early closing hours for businesses and acceleration of the policy push toward restricting access to public venues to those with current vaccinations certificates.
“Combined, these proactive responses are likely to reintroduce a short-term drag on economic growth in Europe, both within the EU and beyond.”
Omicron might be the clear and present danger but there are also other risks for investors to consider. Inflation is certainly one of the most prominent.
In November, the euro area harmonised index of consumer prices increased by 4.9% year-on-year, according to Eurostat, worsening through the second half of the year and moving further away from the ECB’s 2% target rate.
In Lithuania, inflation has reached an eye-watering 9.3%, in Estonia it is 8.4%, and in Latvia 7.4%. It has reached 7.1% in Belgium and an unprecedented 6% in Germany.
Although energy price inflation is the chief culprit, forcing OPEC to consider increasing oil production to cap a spot price that is currently around $70 per barrel, there is also evidence of higher food, services and non-energy industrial goods price inflation.
Central bankers are warning that with strong consumer demand and supply chain difficulties that may only worsen given the added problem of Covid restrictions and workforce absences, the outlook for inflation remains worrisome, but few are prepared to act, not least with economic growth a priority.
Dixon says it is possible that the new Covid outbreak “could tempt central banks to sit on their hands with regard to taking back some of the monetary easing”.
This may seem incongruous, he says, in view of the recent surge in inflation. “However, the nature of the inflation spike is largely the result of supply-demand imbalances and is unlikely to be amenable to monetary policy changes.”
On top of this, Europe is also struggling with an immigration crisis and its economic and political effects.
Piljak says it is threatening political stability in the Balkans, which might escalate to a more serious level.
“Serbia, and Bosnia and Herzegovina are already known as the immigrant route towards the EU (border with Croatia), and the recent influx of immigrants threatens to deepen tensions in the region. Such increased political tensions are seen as a further threat for the economic and political outlook."
This comes on top of new developments in Bosnia and Herzegovina’s political scene.
“The leader of the Bosnian Serbs in the Republic of Srpska entity and the Serbian representative in the presidency, Milorad Dodik, has been announcing plans to withdraw from state-level institutions, including Bosnia’s joint judiciary, military and tax administration," says Piljak.
“As a consequence, the US, the creator of Bosnia and Herzegovina’s 1995 peace accord, threatened to impose sanctions against entities that try to unilaterally withdraw from state institutions or in any other way endanger the peace agreement.”
Gaillard also notes that geopolitical threats are real, including the migration risk (on the southern and eastern borders of Europe) and the Russian diplomatic and military stance against European nations.
Brexit tensions are only a minor issue in comparison, although as other experts point out, there are some specific concerns arising from the unresolved issue involving the Northern Ireland protocol, including the fact it is acting as a deterrent to the US sealing a transatlantic trade deal with its British allies.
Dixon adds that another unrelated area of concern for the UK is the parliamentary standards issue, which “shines an awkward light on the relationship between MPs’ public duties and their business activities and has prompted a modest increase in the risks associated with UK political corruption”.
Gaillard’s attention is on supply chain issues. In the context of post-globalization, he says that Europe has to re-think and secure its global value chains. “This involves new forms of interdependence, selective investments and targeted relocations.”
Supply chain risks are similarly a theme on the mind of Nicolas Firzli, director of the Singapore Economic Forum and advisory board member of the World Bank Global Infrastructure Facility.
He notes that as the UK is out of the EU and seemingly marginalized in the short term, Emmanuel Macron prepares to take the reins of the rotating presidency of the Council of the EU (in the first half of 2022), Germany is now governed by a 'Francophile' centre-left chancellor (for the first time since 2005), and Italy is led by Mario Draghi, who comes across as the older ideological mirror-image of the French president.
There probably isn't much appetite for 'a more sovereign Europe', Firzli says.
“The cynics may say that, for France and Italy, that 'new EU ambition' tinged with grandiose 'green finance' aspirations may be an attempt to bide time: weathering the lingering Covid crisis storm until macroeconomic circumstances are deemed more favourable – hopefully sometime in H2 2022.
“But, in the meantime, the cruel fiscal reality won't go away easily, especially as the very Draghian notion of 'whatever it takes' has pushed the finance ministers and central bankers of the continent (and, arguably, the US and UK too) to throw away the economic wisdom of our fathers: printing money blindly eventually yields inflation, and years of deliberate underinvestment in ports, warehousing, energy and shipping infrastructure can only bring supply chain havoc.”