PARIS — The eurozone is in the recovery room now the danger of a Greek default has been averted for a couple of years, but it is not yet safe from a Japanese-style "lost decade".
The currency area’s escape route hinges more on the pace of expansion in the United States and China, lifting the world economy, than on the policy mix in Europe, which will continue to favour austerity over growth in 2013.
At best, Ireland and Portugal could emerge slimmed down from their bailout programmes and regain capital market access by the end of the year, demonstrating that adherence to a tough fiscal adjustment plan can work.
But question marks hang over both. And Greece, like miracles, will take a little longer. And another debt writedown.
Gloomy forecasts from the Organisation for Economic Co-operation and Development (OECD) and private economists suggest the 17-nation euro currency area may stay in recession all next year, swelling the armies of unemployed and pushing efforts to reduce public deficits and debt mountains off track.
Political risks abound; possible social revolt against austerity policies in Greece, Spain or Portugal; a messy, inconclusive election outcome in Italy; and perhaps labour unrest against more modest structural reforms being mooted in France.
Monday’s European Union (EU)-International Monetary Fund (IMF) agreement to keep Greece afloat inside the eurozone, by reducing its debt now and hinting at official debt relief to come later, has removed the biggest risk of a financial shock that could re-ignite market panic and send the euro back into the emergency ward.
Market relief over the Greek deal, coupled with European Central Bank (ECB) promises to do what it takes to preserve the euro, helped Italy sell its last 10-year bonds of 2012 on Thursday at the lowest yield for nearly two years.
French Finance Minister Pierre Moscovici called it "a turning point for the eurozone because it helps recreate stability and confidence. Greece’s fate will no longer be a daily issue".
European Internal Market Commissioner Michel Barnier, using a soccer metaphor, said the peak of the debt crisis was over and "we are now at the start of the second half".
Some analysts are less convinced.
Mujtaba Rahman of Eurasia Group said the Greek fix "keeps the show on the road, but is no game changer".
The campaign for Germany’s general election in September means that bolder steps towards writing off debt or sharing liabilities will have to wait until at least the end of next year. Public opposition to a "transfer union" in the eurozone’s biggest economy and main paymaster remains high.
Yet no Eurosceptical party has emerged to capitalise on that mood, and the next Berlin government, whether a "grand coalition" of centre-right and centre-left, which seems the most likely, or another permutation, may be more open to such solutions.
The European Commission set out ambitious proposals for closer economic, fiscal and banking union last week, including a common eurozone fund to reward structural reforms, but most big changes will be on hold until after the German vote.
In the meantime, modest progress is likely on creating a single European banking supervisor, the first step towards a eurozone banking union, but without a joint deposit guarantee to deter capital flight and bank runs.
IMF Managing Director Christine Lagarde says swift implementation of a banking union with powers to supervise all banks in the euro area is now the top priority.
Germany will continue to press for stricter European control over budgets in eurozone states, but that will involve trade-offs with greater mutualisation of risk and treaty changes that might only come after the 2014 European Parliament elections.
Many EU officials and analysts expect that Spain, which has so far avoided a sovereign bailout, will have to request eurozone assistance early in the new year, when it needs to raise at least €230bn on capital markets.
That would trigger ECB buying of its bonds, which might reassure investors and further reduce borrowing costs for Madrid and Italy initially.
But it would raise hackles in Germany, given the Bundesbank’s continued opposition, prompting market speculation about the ECB’s will and ability to sustain bond purchases.
Markus Huber, senior trader at ETXCapital, reckons that even though economic reforms and ECB reassurance have cut Italy’s borrowing costs, an indecisive outcome of a general election due in April could send yields soaring again.
Rome is also at risk of contagion if Spanish Prime Minister Mariano Rajoy continues to dither and delay a eurozone credit line for Madrid, he said.
A more remote but much-talked-about risk is the possibility that financial markets could turn against France if President Francois Hollande’s labour market and welfare financing reforms disappoint or meet militant street resistance.
France’s borrowing costs are hovering close to historic lows despite its loss of the coveted AAA credit rating from Moody’s this month after Standard & Poor’s downgraded Paris in January.
Fitch Ratings, the only credit watchdog still to have France on AAA, said last week it could lower that grade if the country fails to meets its deficit reduction targets and its economy performs worse than forecast.
Yet many investors believe France, with a deep, liquid debt market, enjoys an implicit German guarantee and so buy French bonds as a proxy for the strong northern eurozone states that have less debt to issue.
French economist Jacques Delpla, co-author of a proposal for a limited issuance of common eurozone bonds, argues that euro states’ debt will become more attractive in the next few years as other major economies try to inflate away their problems.
"The whole of the world except Europe is going to inflate away its debt — the United States, Britain, Japan," he told a conference of the European Council on Foreign Relations.
"Only eurozone debt will remain strong blue debt because the great German legacy is that we won’t inflate. So part of our debt is going to default, and the rest will become the crown jewels of world debt."
In economic terms, the eurozone’s adjustment should advance further next year, with German wages rising above inflation while "internal devaluations" in peripheral eurozone countries make their exports more competitive and narrow current account imbalances.
ECB President Mario Draghi, who expects most of the eurozone to start recovering in the second half of 2013, cautioned on Friday that the crisis was far from over and governments must consolidate their budgets and reduce current account imbalances.
Optimists such as the Lisbon Council, a Brussels-based pro-market think-tank, and Berenberg Bank say the eurozone is turning into a more balanced and potentially more dynamic economy thanks to market pressure and constant demand for structural reforms.
But the longer and deeper the recession in Spain, Italy and Portugal, the greater the risk of them being sucked into a vicious circle of falling revenues outpacing spending cuts which in turn depress demand and output, causing lower revenues.
At the gloomy end of the scale, economists from Citi said last week they expected continued recession in the euro area in 2013 and 2014 and prolonged weakness thereafter — with ongoing financial strains and, over the next few years, a Greek exit and a series of sovereign debt restructurings.
The euro’s survival may no longer be in much doubt after the ECB stepped in and the Germans decided to keep Greece inside the currency.