Economic outlook: Europe's debt burden

After three years of declines, European construction markets are expected to flatten out this year, with investment levels the same as in 2010. The brake on growth is debt crises in many countries, which is more risky and complex than the problems in the US.

The financial markets have lost confidence in European politicians' ability to deal with the Greek crisis, and the contagion has now spread to Spain and Italy. There are no easy ways out of this crisis for Greece, the other high-debt countries and the Euro-zone as a whole.

The best scenario is a 'soft' restructuring that will involve voluntary debt modification by creditors and tough fiscal austerity in Greece.
The next most likely scenario is a 'hard' restructuring involving a Greek default which will spread Greece's problems to a wider circle of European banks, which may then need bailing-out themselves by national governments (contagion).

The final, far more damaging scenario is that Greece and other high debt countries would exit the Euro.

The need for austerity, particularly in Southern Europe is one of the reasons why southern economies (plus Ireland) are diverging from the core Northern European markets, where Germany and Sweden stand out for their strength.

Even in the soft restructuring scenario, the debt crisis will keep flaring up as repayment deadlines approach, and this will weigh on confidence in vulnerable countries, as well as making their cost of borrowing high. This is expected to see Euro-zone GDP growth slow from +1.9% this year to +1.4% in 2012. In contrast, the UK for example will see an acceleration from +1.1% this year to +1.9% in 2012, boosted by the London Olympics.

Recession impact

Even before the current debt crisis, European construction markets had suffered a torrid few years during the recession. Residential construction is the largest component of the Western European industry and it dropped a staggering -11.4% in 2008 and another -15% in 2009. The decline began to bottom-out in 2010, with a -3.3% fall, and this year growth is expected to return, with a +1.5% rise in output.

The average annual growth outlook for 2010 to 2015 is +1.9%, compared to a worldwide figure of +5.6%. Further out, IHS Global Insight expects a figure of +1.8% growth between 2015 and 2020, again below the global rate of +3.3%. Western Europe's residential spending is not expected to reach the pre-recession levels of 2007 in real terms before 2020.

Germany, France, and the UK have the largest residential construction segments in Western Europe - equal to almost 50% of the region's total in 2010. While the UK has a strong medium term outlook with +5% growth over 2010 to 2015, Germany and France will see much more moderate expansion.

Western European spending on non-residential construction declined -3.5% in 2010, to US$ 572 billion. The office subcategory posted the largest decline, down -5.8%, while the industrial subcategory fared best (or least worst), with a decline of -1.4%.

The sector is expected to see +2% growth this year, accelerating to +2.7% in 2012. The strongest markets this year will be Turkey (+13.3%) and Germany (+6.5%), while Portugal and Spain will see declines and a near collapse in non-residential construction is expected in Ireland.

Average growth for the non-residential construction sector is put at +2.5% between 2010 and 2015, again lagging behind the global figure of +5.1%.

Growth in infrastructure spending fell in Western Europe in 2010, with some countries putting austerity measures in place while others allowed stimulus spending to run. It was a marked change from the average annual growth of +3.4% seen between 2005 and 2010, and the decline in 2010 was the first annual decrease since the late 1990s.

With spending cuts now in place across Europe and perhaps more to come, the downturn in infrastructure spending looks set to continue. IHS Global Insight puts the annual rate of decline at -0.7% from 2010 to 2015, with the value of the sector falling to US$ 445 billion and decreases being seen across the board.

The largest declines will be in Spain and the UK, with public debt the burden in Spain, while the UK will face a tightening national budget and a slow-down following the 2012 Olympic Games.

This will create the worst infrastructure growth outlook in the world. Germany will fare the best among major countries as its economy soars by European standards, yet problems for the wider Eurozone will more than cancel-out large scale public investments in Germany. Scandinavia and Turkey will also be strong infrastructure markets.

Construction outlook

So although the outlook for construction output in Western Europe is improving overall, it is still poor by global standards. The average growth rate from 2010 to 2015 will be just +1.5% per year. However, a turn-around is expected after that, with annual growth of +1.9% between 2015 and 2020, although this will still be below the global growth rate of +4.3%.

The Scandinavian countries will be the best performing over the forecast, along with Turkey. Scandinavia was well-insulated from the recession because of strong fiscal positions prior to the downturn, while Turkey weathered the storm thanks to reforms put in place after the 2001 financial crisis.