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Is It Time for CFOs to Brace for an EU Breakup?

  • By Doug Collins
  • Published: 5/4/2017

With anti-EU populist voices gaining an unprecedented share of the stage in France, Germany and Italy, the stability of the European Union and future economic policies are looking less certain. For American CFOs and treasurers, it’s a tough environment to navigate.

Uncertainty reigns

In France, there’s been a surge of negative sentiment toward the EU, and the election there has the biggest potential to end with a surprise result. There’s one more round of elections to go, and Emmanuel Macron is expected to attract more than 60 percent of the votes. If that happens, a French euro referendum is off the table. But the road to get there could be bumpy—any sign of Macron weakening in the polls could trigger financial market uncertainty. Furthermore, a win by Marine Le Pen would threaten EU cohesion and the viability of the euro. If Le Pen pulls off a victory, for instance, and France reverts to the franc that would undermine the basis of the euro’s entire existence.

Germany’s election, which takes place in September, is least likely to end in a surprise. While Angela Merkel and her center-right CDU party will likely win a fourth term, a win by the center-left SPD can’t be ruled out—it’s recently surged in the polls and draws about 30 percent of the votes. Both parties are pro-European.

The Alternative for Germany (AfD), the only German political party with strong anti-euro, anti-immigrant views, is currently polling at around 10 percent of the vote. Although the AfD will likely enter parliament, it won’t be seen as a viable coalition member. Overall, Germany’s participation in the euro is not threatened. However, CFOs and treasurers should be vigilant and consider preparing contingencies for low-probability but high-impact outcomes, as these seem to be happening more frequently. Issues to consider include the impact on FX markets, trade volumes, and even the credit quality of counterparties in the event of an economic slowdown. 

Of all the European countries with approaching elections, Italy is the most vulnerable to uncertainty, thanks to its subpar economic performance and increasing Euroscepticism. Italian elections are not scheduled until May 2018, but there is a small chance that President Sergio Mattarella will call early elections in 2017. Here, populism takes the form of the Five Star Movement, known for its anti-EU stance and calls for a consultative referendum on membership of the euro. To force such a referendum, the Five Star Movement would need to secure a two-third parliamentary majority—possible only if it receives backing from other Eurosceptic parties. The ideological differences between these parties are large, but a scenario in which they collaborate to force a referendum on the euro shouldn’t be ruled out.

Treasury and finance implications

Although populist parties are unlikely to win in France, Germany and Italy, the risks are worth examining. The effects could include a weaker euro and halted gains in EU economic growth, hurting U.S. exports and impacting businesses operating overseas. Italy especially should be watched closely—any sign of rising support for populist parties could lead to a rise in yields, lower confidence and delayed business investment. What’s more, the resulting risk-off environment could restrain the U.S. Federal Reserve’s appetite for further interest rate increases.

In the short term, the risks of political uncertainty are small since as a whole the eurozone economy is stable. However, financial indicators such as government bond spreads offer some insight into how the financial markets would respond to a populist victory. In France, for instance, there seems to be a connection between yield spread and the election—the sovereign spread peaked in February when news broke about mainstream candidate François Fillon’s embezzlement charges. If higher yields persist, the result will be higher borrowing costs for companies and a weakening of investment.

In each election country, there’s a clear upward trend in GDP, but that could easily change with a populist victory. Italy’s precarious economy makes it especially vulnerable to capital flight if political uncertainty erupts. In addition, Italy leaving the euro is not unthinkable. Indications that the Eurosceptic Five Star Movement is gaining in the polls could result in a rise in sovereign yields, a postponement of investment and a weakening of business and consumer confidence.

Preparation is key

With all the uncertainty ahead, it’s essential for CFOs and treasurers to consider possible short and long-term effects of surprise populist victories in Europe. Trade credit insurance is one tool CFOs and treasurers can use to protect their trading relationships and stay abreast of the performance of European economies and weather any market volatility. The bottom line: We’ve reached an era when the longshot is no longer an unthinkable outcome. The time to consider and plan for unexpected events is now.

Doug Collins is vice president, regional director, risk services, Americas and the international groups unit for Atradius.


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