Key elections and troubling political sentiments in Europe throughout 2017 pose significant risks not only to economic recovery in the region, but also to the very existence of the European Union, according to a report by the SCB Economic Intelligence Center.
While the global economy has shown signs of recovery, political uncertainty in Europe now tops the list of potential disruptions to investor and consumer confidence.
Inevitably, these risks will affect the Thai economy through global financial markets, fund flows, and Thai exports. The results of these elections will also reflect whether European citizens still support political and economic integration in the form of the EU.
Economic inequality across Europe, which is partly a result of the introduction of the common currency, remains at the centre of the conflict among member states and could eventually lead to an end of the euro. Elections in France, Germany and Italy must be closely watched as the three countries make up 65% of the entire euro zone economy. Indeed, the results of these elections will dictate the future of the EU.
France
Frexit is unlikely even with Marine Le Pen's victory. Uncertainty over the coming election in France on April 23 and a possible run-off on May 7 has been causing a ruckus in financial markets. Particularly, the gap between yields of 10-year French government bonds and German bunds reached a record high over the past four years on the day that Ms Le Pen, leader of the far-right National Front, reiterated her plan to pull France out of the EU.
Nonetheless, the latest polls by the Financial Times as of April 3 suggest that Ms Le Pen has a high probability of entering the second round but stands little chance of winning the final one to become the next president. She is likely to lose out to centrist Emmanuel Macron, a former minister turned independent presidential candidate.
Even in the event that Ms Le Pen becomes the next French president, it will be difficult to hold an exit referendum because such a move would have to go through parliament. A survey by Ifop in July 2016 also shows that more than 67% of the French public would choose to stay in the EU.
Germany
Anti-refugee rallies pose a challenge for Angela Merkel in her bid for a fourth term as chancellor. Ms Merkel will face tougher competition than before, as she struggles to lead her country through the European economic crisis and the rising popularity of extreme-right politics.
Also, her approval rating has suffered from brewing anti-refugee sentiment. So far, campaigns on refugee restrictions have proved a winning formula for the Alternative for Germany (AfD) populist party in local elections in some regions. But nationwide popularity of the AfD remains limited. The key rival to Ms Merkel is, in fact, Martin Schultz, the former president of the EU parliament and the leader of Germany's Social Democratic Party (SPD). His pro-EU stance means the case of Germany leaving the EU is not an immediate concern right now.
Italy
The rise of the Five Star Movement (M5S), a far-right political party, could mean Italexit. Since Matteo Renzi, the former prime minister of Italy, resigned after having lost in a referendum to reform the parliament in late 2016, the eurosceptic M5S has been gaining popularity among Italian voters. At the same time, Italians' support for the euro has been on a steady decline, down to 41% at present, according to Eurobarometer.
Anti-EU sentiment in Italy has been on the rise partly due to its chronic economic problems, especially in the banking sector, where the non-performing loan levels reach as high as 18%. Italy has suffered from the introduction of the common currency and the regulations set by the EU. For example, using the common currency that is tied to a stronger economy like Germany, the weaker Italian economy has not been able to rely on exports to speed up its recovery because the euro remains too strong.
Moreover, the Italian government cannot bail out its troubled banks due to restrictive EU rules. The rules mandate that equity shareholders and debt holders of a failing bank must take at least an 8% loss of total liabilities before the government can step in. But doing so could lead to big financial losses among the Italian public. For now, the issue has been partly alleviated, yet many voters have expressed frustration towards the government and have called for an exit from the EU.
What will happen if EU members leave the euro?
In the worst-case scenario, the far right's victory may lead to a disintegration of the EU and eventually the common currency. The desire to pull out of both has been gaining steam in different countries, supported by political parties such as the National Front, the AfD, the M5S, and the Party for Freedom (the Netherlands).
All argue that a return to a national currency would once again give each country control over their own monetary policy, leading to more country-specific developments for better long-term prospects. A weak currency, for weaker economies, will prove beneficial for the export sector, while cutting down imports and boosting foreign exchange reserves.
This could become key in solving many of the economic issues facing some European countries. In addition, leaving the EU would, of course, allow countries to break from the EU's requirement for a free flow of people, a long-standing point of dispute. The issue of refugees, for example, has time and again been a major talking point among far-right politicians.
But the end of the euro may have a severe economic impact as well. Investors may not have confidence in the new currency amid political uncertainty after exiting from the euro zone. Any new currency may, therefore, experience massive depreciation.
If France were to leave the EU, for example, government bonds worth more than €2 trillion (74 trillion baht) would have to be converted into franc, while the falling franc might induce a massive bond sell-off, pushing bond yields up. With high bond yields and a weak currency, borrowing costs would rise, dampening economic recovery prospects.
For Greece, already in the throes of a public debt crisis, a return to the drachma would result in higher debt as the majority of Greek debt is in euros. A weak drachma would push up Greece's debt burden, potentially resulting in continuing defaults.
As for Italy, problems stemming from bad debt in the banking sector would be exacerbated due to a weaker currency, driving up recapitalisation costs and potentially leading to an economic crisis. A currency switch would lead to higher prices of imported goods, affecting the cost of living and economic growth. And if the government were not careful about printing new bank notes, hyperinflation might follow, as happened in Russia in 1992.
Even if only one country decided to forgo the use of the euro, consequences may be wide-ranging as all countries in the euro zone are closely linked economically.
A eurosceptic party victory could ramp up volatility in the financial markets similar to the case of the Brexit referendum. Unexpected election outcomes will cause panic among investors. Fund flows could fluctuate, leading to sudden changes in exchange rates.
Among others, the French election is the most concerning event as the market participants believe that Mr Macron will win. This investment position is reflected in the closing gap between French and German government bond yields and falling credit default swap rates in France. Given this development, an opposite outcome could weaken the euro.
But a Frexit referendum is still a low probability event. According to a Bloomberg survey, most analysts forecast that, if Ms Le Pen wins, the euro could depreciate by 7% to a 15-year low at one euro per US dollar.
The European Central Bank (ECB) may postpone its monetary tightening if political developments pose risks to the region's recovery. The ECB may not be able to taper its quantitative easing (QE) programme further.
The ECB is expected to reduce the QE's monthly asset purchase amount from €80 billion to €40 billion from January 2018 onward. The bank may also delay its policy interest rate rise from the current projection in the second quarter of 2019.
In the long run, an exit by an EU member could cause an economic recession, hurting Thai exports. But such an event could open opportunities to make new trade deals that are more beneficial for Thailand.
A scenario of economic recession caused by an exit by a member from either the EU or the use of common currency could hurt the region's demand for imports. If the euro-zone economy contracts by 1%, demand for imports could shrink by more than 1.5%.
Thai exports to the euro zone make up 9% of the country's total. Key products include computers and parts, and cars and parts (graphic 2). By leaving the EU, a country could negotiate new trade deals with other countries. This opens up new opportunities for a bilateral trade deals with Thailand and Asean.
Such deals may face less constraints as the process could be less complex than with the EU.