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By Win Thin
Early Dutch elections appear certain now as, contrary to press reports late last week, budget talks collapsed over the weekend with no deal at hand. The cabinet held an emergency meeting Monday, as Liberal Prime Minister Rutte was unable to get a budget deal after the Freedom Party withdrew its support, which the Liberals needed as a minority government. The government has been pushing for more spending cuts after studies suggested that without further austerity, the country’s budget deficit would come in near -4.6% of GDP in 2013 and stay above the -3% limit into 2015. A caretaker government would still need to present budget cuts to meet EU fiscal rules by April 30. The government is doubling down on austerity, with Finance Minister de Jager still pledging “disciplined” budgetary policy despite recent developments. Rutte will meet with Queen Beatrix later today, with early elections likely to be announced.
Polls over the weekend suggest new elections would not produce an easily workable coalition, with the Liberals leading but still needing the support of up to three other parties to govern. This suggests further policy deadlock lies ahead. Furthermore, one poll also showed 57% of the populace opposed to austerity measures. Of course, this brings into question whether the Netherlands can pass the Fiscal Compact, despite being part of the core and a leading proponent of tight budgets and fiscal responsibility. Officials from the opposition Labor Party have suggested they will back a caretaker budget in return for fresh elections within three months. Local press reports suggest elections are unlikely ahead of September, which raises the odds that Fitch will take negative rating action against the Netherlands when the agency meets in June.
Fitch official suggested last week that the typical rating process is for a move first on the outlook to negative, followed by review for possible downgrade, and then an actual downgrade. Clearly, the usual rating agency metrics no longer hold given actions during this debt crisis and Fitch could very well announce a full-blown downgrade from AAA this quarter, well before any new government can come in to try and regain confidence of the markets and the rating agencies. Our sovereign ratings model shows the Netherlands as AAA, but growing political and fiscal risks have pushed the country closer to Austria, which was downgraded by S&P to AA+ and put on negative outlook by Moody’s earlier this year.
Fitch has not been as aggressive as the other two agencies, keeping Austria and France at AAA up until now. As such, its negative comments about the Netherlands are noteworthy and likely signal a harder line by Fitch in the coming months. As a result, we think both Austria and France are likely to come under negative scrutiny by Fitch as well, as we view both as inferior credits to the Netherlands. Furthermore, the uncertain outlook for politics and policy in France now put the nation on par with Belgium in our model, which we (and the agencies) view as a AA/Aa2/AA credit.
Source: Bloomberg, BBH
The Dutch economy is already in recession, shrinking q/q in both Q3 and Q4. Despite following the German model of austerity, the Netherlands is still suffering from debt and deficit issues. Indeed, we continue to believe that the negative feedback loop in the euro zone remains intact, with austerity simply deepening the recession and making fiscal numbers even worse. Spain earlier today reported another q/q contraction in Q1, which seems likely to be reproduced by the Netherlands too. The fact that April euro zone composite PMI came in weaker than expected and below 50 for the third month in a row and seven of the last eight suggests little relief ahead overall for the region in Q2.
The euro has remained resilient, but another test of the 1.30 level seems likely given the more negative news stream out of the euro zone. As we have highlighted in the past, it appears that political risk and economic risk remain intertwined and likely to surprise to the downside in the coming weeks. Dutch 10-year spread to Germany today is at a record high 74 bp, and timing couldn’t have been worse as the Netherlands will auction 2- and 25 year paper Tuesday.
About Win Thin
Win Thin is the Head of Emerging Markets Currency Strategy at Brown Brothers Harriman. He has a broad international background with a special interest in developing markets. Win received his Ph.D. in economics from Columbia University in 1995, specializing in international and development Economics. He received an MA from Georgetown University in 1985 and a B.A. from Brandeis University 1983.
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