Europe and EM: Resilience and Vulnerability

Vulnerability depends on many factors, not just on the actual exposure to emerging markets but also on the resilience of the European economy, which Citi believes is relatively strong.

First, it matters where the epicenter of the shock lies, as Europe would be more affected by a crisis in one of its neighbour EMs (e.g., CEEs, Russia, Middle East) than in LatAm or Asia. This vulnerability goes beyond economic links but extends to geopolitics, with Europe relying on its neighbours for its energy security and control of refugee flows, for example.

Second, the degree of domestic resilience and the ability to cushion the shock (potentially also via policy action) also determine vulnerability. Citi notes that the Eurozone today is likely to be more capable to withstand a shock than in recent emerging market wobbles.

Domestic demand has been the main and stable engine for GDP growth since mid-2015, supported by strong job creation, falling unemployment, rebounding credit growth and, more recently, by some wage acceleration. Public and private balance sheets have been rebuilt, adding to the resilience. Investment decisions may be affected by an EM slowdown but private consumption probably far less. In that sense, the situation is more similar to the situation around the 1997/98 Asia and Russia crises than the taper tantrums in 2013-14, which unfolded their impact just as the Eurozone was coming out of its second domestic recession following the sovereign debt crisis.

However, Citi analysts stress that the Eurozone is far less vulnerable to EM troubles at the moment than a few years ago given (1) domestic demand has become the key driver of growth; (2) those European economies most exposed to EM tend to also be Europe’s most successful; and (3) public and private balance sheets have been rebuilt, especially in the financial sector, strengthening financial resilience.