High debt and the real estate bubble are among the biggest risks to the eurozone economy and its recovery from the recession caused by the covid-19 pandemic. High government support kept much of the eurozone afloat during the pandemic. However, canceling aid will be difficult as it could increase bankruptcies and unemployment, hampering growth and jeopardizing banks. This was stated by the European Central Bank in its regular stability report.
Risks for euro area countries are increased but uneven. Targeted stimulus will be needed to revive the region from the coronavirus crisis, as the pandemic has affected different sectors differently. The biggest impact was on tourism and hospitality. The risks are thus focused on certain countries and parts of the economy.
“Governments face a delicate balance between early adjustment of support measures, which could help trigger a wave of corporate bankruptcies, and sustaining support measures for too long, and the long survival of companies that are no longer viable,” the bank said in a statement.
Continued state support to the private sector could also raise concerns about the medium-term sustainability of public debt in vulnerable countries in the region, as public debt rose last year, the ECB warned. Nevertheless, the Bank considers the risks of higher government debt to be very low in the near future due to low interest rates and the trend of issuing low-interest bonds with extremely long maturities.
The ECB is also concerned about higher corporate indebtedness in countries with large service sectors, which could increase pressure on governments and banks in those countries. The profitability of banks in the euro area also remains weak, and banks will therefore be forced to increase their reserves for loss loans.
Another threat is real estate prices, especially commercial real estate, a market characterized by high demand and excessive value in the years before the pandemic. Commercial real estate prices are facing a major correction as work habits have changed during the pandemic, and further price declines are likely, which could lead to loan losses or loan collateral problems. This could be a significant problem, as commercial real estate loans account for seven percent of bank loans to the private sector, the ECB said.
Residential real estate markets are in better shape, but even here there is a noticeable overvaluation, partly due to very cheap loans. The risk of correction has increased here. However, the ECB does not expect prices to fall next year, but rather a slowdown in growth, Reuters reported.