7th January 2010 by Shaun Richards
The situation regarding Greece has developed further in the new year. Some of this has happened affecting Greece directly and some is more indirect concerning its relationship with the Euro zone and in particular the European Central Bank (ECB). In essence there are two underlying questions on everyone’s lips
1. Can Greece gets its fiscal situation under control?
2. How much assistance will the ECB give Greece in its current crisis?
If we start with the first question then one has to consider what Greece needs to do. The target for the fiscal deficit for 2010 is 3% of Gross Domestic Product (GDP) under Growth and Stability Pact rules and the target for its national debt is 60% of GDP. Left to its own devices the fiscal deficit for this year would be in excess of 12% and the national debt would rise to 121% of GDP. Therefore Greece will need to tighten by around 4% per annum if it is to get its fiscal deficit back in line by 2011/12. This will prove no easy task.
The Greek government proposed a new fiscal plan at the end of last year (please see my articles on the 9th,11th,17th and 29th December 2009). However after pressure from the ECB and other governments in the Euro zone it came up with a newer plan on the 5th January. However it does involve structural reforms to the Greek economy which cannot avoid hitting the supporters of the current Greek government.For example there will be pay cuts for some Greek civil servants and pay freezes for others whilst there will be an overhaul of the tax and social security system. However more detail is needed if markets are to be really convinced.The new plan expects to reduce the fiscal deficit to 8.7% of GDP this year.
These are hard targets to achieve and will involve much pain for Greece. All this must have come as quite a shock for the ordinary Greek citizen who has become used to “years of plenty” in the run-up to and then accession to the Euro. One problem for them is that as this year the Greek economy is not only not expecting to grow but in fact shrink by around 1/4% after a fall of 1.3% in 2009 then it may find it hard to collect the level of tax revenues it requires to hit these targets. It is not alone in this situation but its high level of national debt to GDP makes this situation more uncomfortable for Greece.
Addressing the second question is complicated by the fact that different authority figures in Europe have said different things. Jurgen Stark an executive board member at the ECB has announced in public that the ECB would not bailout Greece. Whereas Angela Merkel the German Chancellor has been more ambiguous. “The markets are deluding themselves when they think at a certain point the other member states will put their hands on their wallets to save Greece,” said Herr Stark.
This to me is mostly posturing. The ECB can afford to take a hardline stance for two reasons. The first is that it may put pressure on Greece to take further action. The second is that any bailout would be a political decision as the ECB has no authority to bailout Greece anyway. So whilst its first aim appears to be having some success it can maintain a hardline posture knowing that the real decision will be taken elsewhere. Realpolitik anyone?
As to Europe’s politicians I would imagine that they will delay as long as possible in coming to any decision. The truth is that Greece is far more likely to receive some help if it is alone in its current problems. If it carries out its current plans it will be easier for Europe to help it but it mostly depends on how many other countries hit trouble.
Ireland versus Greece: A lesson
Having looked at relative 10 year bond yields I decided to go back a month or so to November 4th 2009 to see what the situation was then to look at pre-crisis levels. The results leapt off the page. At the close of business Greek yields were 1.41% over German bund yields whilst Irish yields were 1.43% over them. Last night Greece was at +2.24% over and Ireland was not far off being unchanged at 1.48% over.
So as recently as early November Greece was in market terms perceived to be better off than Ireland! There are two reasons for the change in my view. Ireland acted aggressively when it came to dealing with its fiscal position and the ambiguity (I am being polite here) about Greece’s financial statistics combined with a less aggressive response led to ratings downgrades and market re-evaluation.
Greece Alone: An improvement
As the situation has calmed down and Greece’s Finance Minister has proposed a tighter fiscal strategy then Greece’s relative position has improved in terms of its government bond market. It’s 10 year yield differential with German bunds went out well over 2.5% and looked as if it might head for 3%. On my last update on the 29th December it was 2.44% and is now 2.24%. The two-year bond I have been following had a yield of 4.03% in my last update and is now 3.71%.
As Greece has found that its government debt has been assessed more favourably relative to other markets debt markets in general have fallen. So in real terms there has been little or no gain. But world markets ebb and flow and at least the situation has stopped deteriorating for now.
Lesson for Everyone
Many governments around the world are facing higher national deficits and implied higher levels of national debt. So far the focus has been on fiscal plans (and indeed Keynesian policies). Going forward any improvement will depend as much on economic growth, in fact any real improvement in my view will mostly depend on economic growth. I have made proposals for improving the UK’s growth rate in previous articles and feel strongly that all countries should encourage rather than strangle economic growth over the next few years. There are two sides to a national debt to GDP ratio. I would refer everyone to my article on Japan in crisis on the 30th December 2009 and for them to look at what anaemic growth has done to their tax revenues if they doubt this.