Monday, December 3, 2012

21012 in review: Greece revisited


As the year comes to a close, I feel that it is healthy to revisit the posts written so far and to assess how events have tracked our expectations and predictions.  This is the first installment of the series.

It has been our view that Greece would not be able to fulfill its commitments to the rest of EU and that the adjustments it needed to make were so great that it should and would leave the eurozone, at least temporarily, if not this year at least next.  We have also felt that the single most effective tool at its disposal to correct excessive debt loads was privatization of public assets, which it has refused to implement: of some €300 billion in privatizable public assets[1], only €50 billion were earmarked for sale, and to-date, cash proceeds to the Greek government have been €1.8 billion only. 

So far, Greece remains in the eurozone despite having spectacularly failed meeting its targets and carrying unsustainable debt loads.  Last March, the Greek government agreed to a series of targets with the Troika (European Commission, ECB, IMF), such as bringing its debt-to-GDP ratio down to 120% by 2020; despite a severe “haircut” imposed on private creditors, that ratio stood at 150% by mid-year and was budgeted to rise to 189% by 2014.  Such huge “miss” was due to both a collapsing economy and rising debts.  The budget deficit target will be missed as well.  Further adjustments include more cuts in public sector salaries, pensions and other social transfers, and of course, better tax collection.

Faced with unattainable goals, the Troika decided to fudge, increasing the 2020 debt-to-GDP goal to 124%, reducing interest rates on loans to Greece, returning realized profits on previous ECB financial aid operations and requesting Greece to buy back debt[2] (at a discount) before disbursing the next aid package.

This next disbursement of €34.4 billion is not assured yet.  It is also huge as it represents 17% of Greek GDP[3].  It is worth noting that Germany has become increasingly skeptical of the viability of the Greek rescue, and not without reason: Greece keeps missing its targets, its debts remain very high and the above mentioned budget cuts are likely to stoke further political instability and push an ever larger share of the economy underground, reducing tax revenues and distorting further the economy.

Having forced private creditors to take a €106 billion loss without putting its debt on a realistic recovery path, Greece will ask the same from its public creditors next.  Despite the IMF insistence, the eurozone has so far adamantly refused, although chancellor Merkel recently acknowledged the inevitable, sort of.  Large scale privatizations continue to appear out of the question.

The problem is that, while another round of debt haircuts appears necessary, it is not sufficient to get Greece back on track.

Nowhere in Europe has the pain been greater than in Greece:  Nominal GDP dropped 7.6% from €232.9 billion in 2008 to an estimated €215.1 billion in 2011.  It is expected to drop close to 7% this year.  Labor costs have been greatly reduced and external accounts have adjusted considerably, although in large part because of low internal demand: the trade deficit[4] for the first nine months of 2012 was €10.1 billion compared to €18.6 billion in 2009 and €32.7 billion in 2008.

For the period 2009-2012, the Greek GDP will have fallen as much as that of Chile did in the early 1980s, yet the comparison stops there.  Chile carried out profound structural economic reforms during its depression years while Greece hasn’t.  Unless Greece invests massively to become more productive and to shift its output towards greater value added products, unless it shrinks its public sector, unless it designs a tax system that is efficient without being confiscatory, the above adjustments will prove to have been cyclical rather than structural.  So far, the situation is grim: for example, total investment as a percentage of GDP has gone from 23.7% in 2008 to 14.5% in 2011 and is likely to drop further this year.

At this stage, the odds of Greece remaining in the eurozone are slim although less dismal than they were last March.  To remain, it is necessary that Greece get a large debt reduction, but it is not sufficient.  Besides reforms it also needs the European Union, which absorbs over 62% of its exports, to recover too.

So far, it seems to me that Greece’s condition has gone from desperate to critical; perhaps there is room for further improvement.  The eurozone countries are starting to acknowledge that they can’t fully collect their loans to Greece.  They have yet to decide which avenue is best for them: granting a large haircut as the final boost to a recovering country and fellow eurozone member, or cutting their losses to a country exiting the eurozone.

I remain in the camp of the skeptics.



[1]  As per former ECB Board member J. Stark.
[2]  Essentially directed at the new bonds which Greece issued as part of its private debt restructuring.
[3]  Source: UBS.
[4]  Excluding oil products which are not included in the official time series.

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