On Saturday, December 17, the leaders of the member countries reached an agreement about the next EU budget at the Brussels Summit. After two days of extremely tough negotiations, representatives of the 25 member states of the European Union approved a budget of €862.4 billion for the years 2007 through 2013.


Bringing 25 countries to an agreement was not an easy task, despite the pragmatic approach of German chancellor Angela Merkel, who performed the role of mediator. One of the main obstacles during the negotiations was Tony Blair, the British prime minister, who holds the rotating post of president of the European Union. Blair was not ready to cede anything to his counterparts. Ultimately, the inspiring principles of the European Union won out. Blair agreed to give up a portion of the benefits that the United Kingdom had negotiated regarding the contributions that it makes to EU finances. However, the budget that negotiators approved in December has to be approved by the European Commission and its Parliament.


This was not the first attempt to reach a budgetary agreement. Last June, there was another failed effort when member states were unable to compromise their various interests for the good of the Community. After 15 hours of debate, Jean-Claude Juncker, whose turn it was then to be president of the European Union, gave up the fight. Juncker withdrew the final compromise budget for the European Union after it was rejected by the United Kingdom, the Netherlands, Finland, Spain and Sweden.


The European Parliament has criticized the [December] budget agreement reached by the Twenty-Five. The European Chamber is committed to fixing the final budget at 1.045% of the GDP of the 25 member states, so approval by the legislative body   will be required for exceeding that ceiling [in the new budget].


The European Constitution: An Issue to Mull Over


Once the European Parliament approves the new budgetary pact, the EU will have another issue to mull over: What should be done about the Constitutional Treaty that France and the Netherlands have rejected? At the moment, the European Parliament, whose approval is indispensable if the budget is to go ahead, has made this key decision: There will be no further expansions [of the EU] without a new Constitution.


Although France and the Netherlands said ‘no’ last spring, the Constitution of the EU is a key element in future expansions [of the EU] because it established a new system for making decisions. However, the Constitution is now practically dead. The member states have decided to establish a waiting period — “a period of reflection,” as it has euphemistically been called — in an attempt to find a way out of this dilemma. They have set the first half of 2006 as a period when the Twenty-Five [EU nations] reconsider how to continue this process. During Austria’s six-month period as revolving president, which began on January 1, this issue will be one of the priorities.


What are the chances that the Constitution will move forward? The European Parliament has proposed that the European legislative body initiate a series of debate forums. Participants in these meetings would have to draw conclusions about which road to follow. There are a wide range of possibilities, from abandoning plans for a Constitution altogether to continuing the ratifications (although the rejections by France and the Netherlands permit very few alternatives). There is even the possibility of putting together a new Treaty.


“The prospects for the European Union in 2006 are powerfully influenced by the agreement on financial prospects for the period 2007-2013, both because it was negotiated under very difficult circumstances, and because the prevailing approach is to compare what is given with what is received,” says Juan Antonio Maroto Acín, professor at the Complutense University in Madrid, adding that “It is bad news for Europe that they are putting more stress on the economic benefits than on benefits that derive from a community that shares the ideals of union, social rights and progress.”


Last year was not a very good year for the European Union because of the failure of the European Constitution. The economy also grew by barely 1% in 2005 because of “weak internal demand, and scant growth in the export sector, which was the main engine of economic growth during the last three quarters of the year,” notes Sergio R. Torassa, finance professor at the European University.


Nevertheless, Torassa is optimistic about 2006. “You can see some positive signs in the economic environment; some advance indicators seem to indicate the start of a clear recovery. The greater strength of industrial activity justifies some optimism, and the increase in global demand should continue to favor exports. Those factors could enable the Euro zone’s Gross Domestic Product to grow by about 1.7% to 1.8%.” At the end of December, the European Commission announced that the economic growth in the Euro zone is now accelerating. It projected GDP growth of 0.6% during the fourth quarter of 2005, the same rate during the first three months of 2006. For the entire new year, it projected GDP growth of about 2%.


According to Maroto, “Germany, the EU’s largest economic power, is sending positive signals that enable us to project a slow recovery, with a growth rate of up to 2%. That’s especially likely if interest rates are maintained [at the current level], and if oil prices are relatively stable.” Analysts say this recovery will be led by exports. In addition, consumer confidence indicators suggest that internal demand will provide a boost. The countries on Europe’s peripherym such as Spain, Ireland and Greecem will contribute significant growth, although the growth differential with the central core of the EU — Germany, France and Germany — will be reduced.


Interest Rates and Oil are the Biggest Risks


Maroto also perceives some risks, including higher interest rates that could undermine the consumer confidence; another rise in the price of oil; and rigidity in traditional sectors when it comes to reacting to unforeseen changes in the financial and economic world.”


Altina Sebastián González, finance professor at the Complutense University in Madrid, adds her own negative comment. “There are clear clouds on the horizon, and they will put downward pressure on prospects for the new year. On the one hand, low costs in emerging economies constitute a threat for the developed countries of Europe. On the other hand, rigidity in the labor market, protectionism and [EU] bureaucratic regulations all provide obstacles to efforts that many European companies are making to compete effectively against their counterparts in China, Japan and the United States.”


Interest rates are a risk to economic stability in Europe. However, experts say the European Central Bank’s fixed interest rate, now at 2.25%, has a stimulatory impact on the economy. The ECB has expressed its intention to continue to gradually raise rates, and analysts expect that the ECB will raise rates by another half-point through 2006. “At this time, the real problem for Europe is the dilemma of how to control inflation without cooling off the economic cycle,” explains Torassa. He says the ECB’s latest measures received cool reviews from “economics and finance ministers in various countries, as well as from the IMF and the OECD. The big challenge for the ECB is to achieve confidence in the markets. Without that, whatever decision they take, it will not have the expected impact on the economy.”


Prices for crude oil and fuel, which reached historic heights in 2005, will continue their climb in 2006, experts say. Nevertheless, Torassa believes that “prices below $69 per barrel would permit the global economy to maintain its current rates of growth. The reports of experts are relatively positive.” Merrill Lynch forecasts an average oil price of $65 a barrel for 2006, and the U.S. Energy Information Administration estimates that the average price of WTI [West Texas Intermediate] crude oil this year will fluctuate near $63. For its part, Standard & Poor’s forecasts that the average price of oil will be $58.50 per barrel.


Germany Begins its Recovery


Overall, experts foresee a year without any big surprises. If the forecasts are accurate, Germany could begin its recovery. “The recent approval of the ‘United for Germany with Values and Humanity’ program, led by the government of Angela Merkel, has generated euphoria about the prospects for Europe’s largest economy, which seems to be plunged in a profound recession,” says Altina Sebastián González.


Until only a few days ago, analysts were estimating Germany GDP growth at 1.2% for 2006, but they have since raised their estimates to 1.7%.  Sebastián González notes that “the most important measure in the [German] program involves bringing the public-sector deficit back down below the 3% of the GDP anticipated in the [EU] Stability Pact, which is now on the verge of 4%. To do that, they will increase the Value Added Tax from 16% to 19% in 2007. They will also increase the personal income tax by 3% in the highest brackets. In a parallel initiative, the government has committed itself to carrying out a public investment program of €35 billion over the next four years.”


Portugal is another country where the forecasts are positive. Portugal’s GDP grew by 0.3% in 2005, and experts foresee a moderate recovery in economic activity over the next few years. GDP growth is expected to reach 0.8% in 2006, and rise to 1% in 2007. Growth will be sustained by exports, while internal demand will behave quite the same way as in 2005. The main threat hovering over the Portuguese economy is the growing competition that its exporters face in global markets.


Forecasts for the other European powers are not as optimistic. Despite the surprising growth of the French economy in the third quarter of 2005, the same trend is not expected to continue in 2006. “This growth is not supported by solid fundamentals,” says Torassa. “Internal consumption presents clear signs of weakness; confidence has not yet recovered, and the labor market showed an unemployment rate of 10% through October. On the other hand, neither the industrial sector nor the service sector offers a reason for an optimistic forecast.”


As for Italy, Torassa adds, “The Italian economy continues to show no signs of recovery. It has even shown that it is unable to take advantage of the favorable international situation. Italy’s exports fell during the third quarter by 1.1% on a year-to-year basis. Meanwhile, its imports grew by 2.6%. As a result, external demand reduced variation of the GDP by 1.1%. Nor will 2006 be a good year for Italy. The only good news is that inflation has been contained at about 2%,” he adds.


Forecasts for the United Kingdom are equally negative. “The bonanza years seem to have ended,” says Torassa. He cites Gordon Brown, Britain’s Chancellor of the Exchequer, who has projected growth of 2.25% in 2006, 50 basis points (0.5%) down from his earlier forecasts. “Once again, the exhaustion of consumption and weaker industrial production are taking an economic toll. The real estate sector has entered a lethargic phase; prices for housing rose last November at their lowest rate since 1996, and it will be hard for things to recover this year.”


“The recovery in European growth will be good news because it will enable Spain to alleviate the lethargy in its export sector, which is mostly directed toward Europe,” notes Maroto. “Interest rates and expectations that the cycle has bottomed out will weaken private consumption and demand for housing but that will not harm corporate earnings. Gross formation of fixed capital — that is, non-residential and public construction plus investment in capital goods — could gradually substitute for the role of private consumption. As for salary expenses, the cushion of temporary and part-time employment will permit companies to maintain their salary expenses, despite increases in the cost of full-time employees.”


“The greatest dangers for Spain are that Europe’s economy does not take off, that this also happens in the southern countries of the EU, and that they [the Spaniards] underestimate their managerial shortcomings and the lack of competitiveness of their small and midsize companies,” adds Maroto.


A Year of Mergers


“In mergers and acquisitions, psychological factors are involved in the processes and the way that they spread. Nowadays, those psychological motives are apparent in globalization because companies need to increase their competitive scale,” says Maroto. Another factor is “the doctrine of ‘national champions,’ through which European countries try to promote their big old public companies, which have been privatized.


“These goals cannot be undertaken effectively unless interest rates remain low and there are high levels of liquidity, and unless there is growing stimulus from investment banks and venture capital companies,” Maroto adds. “Current data suggests that this process, which integrates both … information technology and communications, will continue in such sectors as trade, transportation and logistics, as well as in real estate and construction.”


Analysts estimate that the total value of mergers and acquisitions in Europe last year was €984 billion. Banking, manufacturing and telecommunications were the sectors with the most activity. “2005 is going into the annals of investment banking as an excellent year for specialists in mergers and acquisition. The abundant liquidity of risk-capital companies, added to the growing volume of deals in the financial sector, were the main drivers of this phenomenon,” says Sebastián González.


In the short term, she adds, “it seems that this trend will not be interrupted because a large number of deals are already in play. Growing concerns about eliminating nationalistic, protectionist barriers and about creating truly European groups of business executives are other factors behind the continuation of this trend. In addition, risk capital funds continue to be an important vehicle for capturing savings, so these deals have access to abundant liquidity. New investment vehicles have also emerged, such as REITs [Real Estate Investment Trusts] in Germany. Moreover, the ETF (Exchange Trade Funds) that were anticipated in the Ruling of Collective Institutions of Investment, which Spain approved last November, will require institutions to make larger volumes of investments.”