17 December 2012

Greece: Litmus Test for Eurogroup and IMF

In the ongoing eurozone debt crisis Greece has received disproportionately much attention by the policy makers, investor community and news media when compared to its size and its total debt in absolute terms. It has also received way too much international “aid” and been “forgiven” far too much debt by the private sector creditors. Why is that and what does it mean?


Greece – actor in the foreground

Even though by now well told stories about Greece’s earlier reckless public spending, manipulations with statistics and so one (for example, read a few chapters from the Michael Lewis’s book “Boomerang: Travels in the New Third World”) gave a good motive for making Greece the scapegoat of the Western World at first place, there are other not less important reasons too.

A debtor’s problem is a creditor’s problem, and if you look at the total external liabilities of the various so-called advanced economies (see Table 1 in my previous post), you see that there are plenty of such debtor-creditor problems in much bigger absolute amounts still waiting for addressing. For example, while Greece’s gross external liabilities as of Oct. 2012 were 204% of country’s 2012 projected GDP, the comparable number for France was 296%, for Spain 225%, and for eurozone as a whole 194%. All “PIIGS” except maybe Italy but notably Spain, have staggering external liabilities on net basis as well.

Greece was the most vulnerable country because of the heavy concentration of its total debt into one sector, the public sector. However, as we have seen so many times in the economic and financial history, excessive private debts, especially financial sector debts, have a strong tendency to convert into public debts sooner or later (the opposite is true a well). So an over indebted country or grouping of countries such as eurozone today, will ultimately have to somehow reduce its overall debt burden.

In other words, as long as there is no good solution for the debt super bubble or whatever we call it, from a policy maker’s perspective it totally makes sense to draw all the attention to a pin rather than the elephant. This is the more true when you think about how the financial markets work: the first concern far too often is not what the situation actually is, but what the others might think of a piece of news in short term (one of the first lessons for a trader).

Even so, as time is passing, Greece’s debt story is becoming something much more for the eurozone policy makers and the IMF. What I just said about the debts, is barely a secret to anyone who has bothered to look at the data, read a few financial blogs or some good books about the recent financial crisis. (I’m currently reading Roubini’s “Crisis Economics: A Crash Course in the Future of Finance”, for example.) This fact makes Greece’s case a challenge for them: “If you cannot deal even with this “small problem”, what can you do at all?” In other words, Greece has become a true litmus test for their ability to perform when it comes to any current financial and economic issues.


Key question (one of the two in eurozone now)

The obvious question now is: “How well are they doing today in Greece?”

If they manage to solve this case, perhaps they really qualify for moving on, or more likely reckless party can continue for some more time. Otherwise, well, the Roubini’s forecasted train wreck seems far too real.

That’s one of the two considerations what currently, with the help of the financial media, seems to be driving market expectations about the future of eurozone. (The other consideration relates to the progress towards banking union.) And, as we know, expectations tend to be self-fulfilling prophecies...


Never leave praising yourself for the others to do

One statement after another, officials have started to announce no less than what sounds significant progress or full assurance about the future success. Here are some of the most recent ones made after the 26/27 November deal to cut Greek debt by another x billion euros (underlines are mine):

On December 13, 2012, Ms. Christine Lagarde, Managing Director of the IMF said:
“I welcome the Eurogroup’s decision to support the debt buy back operation for Greece and its assurances to provide additional debt relief if necessary and provided Greece has achieved a primary budget balance in 2013. These steps will ensure that Greece’s debt-to-GDP declines to 124 percent by 2020 and to substantially below 110 percent by 2022.”

On December 13, 2012, the Eurogroup announced:
“The Eurogroup reaffirmed that this [i.e. the second disbursement under the second economic adjustment programme for Greece], together with the initiatives agreed by the Eurogroup on 27 November and full implementation of the adjustment programme, should bring Greece's public debt back on a sustainable path, to 124% of GDP in 2020. Greece and the other euro area Member States are prepared to take additional measures, if necessary, to ensure that this objective is met.”

27 November 2012 statement by EC President Barroso on Greece:
“...The Greek authorities have demonstrated a strong commitment to the programme and the Commission salutes the efforts made by Greek citizens in this difficult time. The Commission continues to consider that these efforts will contribute to a better future for the Greek people.

Indeed, policy makers are not tight-fisted with praises and salutations.


Real progress or wishful thinking

Are the above praises for a real thing or just to prop up public mood and market expectations?

So and so, depends on our viewpoint and what we are considering as the desired outcome. For example, a Greek person (or a similar person from whatever nationality) who doesn’t pay taxes or bills, and otherwise uses to live beyond his or her means, might argue that defaulting at some point down the road with maximum amount possible is the measure of success. An honest Greek person might have a different opinion. Someone betting on eurozone break-up has apparently other interests than those who have built it up, even though incomplete. Let’s leave these differing angels for now, and define success as getting Greece’s economy and public finances back on track within the eurozone.

Despite of all scepticism, eurozone still does exist (and with high enough likelihood continues to exist, which I have indicated more than once), and Greece is still a member of the eurozone (which is more certain now than it was a year ago given what has been invested into it). It might be viewed as a political success of European-level leaders in itself to get eurozone ministers from different countries delivering more-less consistent messages when it comes to sharing losses, especially taking into account fragmentation that has been happening during the past few crisis years. Progress has apparently been slow, but that’s the price of democracy and consensus politics (right or wrong is another debate).

Based on pure economic and financial statistics, the results so far look bleak, though (see Table 1 below). Yes, Greece’s government has been working rather hard on cutting expenditures, but raising revenues has proven to be more-less mission impossible and government debt has soared from ca. 130% of GDP in 2009 to more than 170% in 2012 (ironically rapid worsening of the situation indeed). When we look at the declining economy (GDP), skyrocketing unemployment figures and still negative external balance of goods and services, this result is no wonder. At least in numbers financial sector has been kept alive – but this most probably is an illusion, starting from the fact that they have write-offs due from government debt. The only positive news basically is that country’s international competitiveness is improving – as a result of declining labour costs rather than anything else. Whether internal devaluation works, is still not quite sure: consumer prices are still not coming down, for example.


In short: not surprisingly, the medicine of loans from the fellow euro area members, EFSF and the IMF has not worked once the country already was on unsustainable path by the end of 2009.

Not that the Eurogroup and the IMF haven’t understood it – if not earlier, then by now they do, and far too well. At this point, Greece’s people might struggle and work like crazy (not that they certainly do), but debt burden would still increase simply because of interest expenditures on this 1.7-1.8 times GDP debt burden, especially if market prices had to be paid. But what choices do they have given that Greece’s disorderly default is not an option in their “menu”? Right: engineer an orderly default. That’s what is being done.

By the default-engineering exercise policy makers have notable restrictions too. Just to name a few:
* Reduction of debt should not look like outright default (an eurozone country doesn’t default, that was the promise);
* Too big or too interconnected to fail financial institutions that are holding Greece’s debt or have written credit default swaps on Greece’s debt, must be kept alive (there is no final list of such institutions);
* The ECB owns a significant amount of Greece’s public debt when compared to its capital, so it cannot easily afford any write-offs (few know how much exactly via various financing schemes, but it’s significant);
* German/Nordic tax payers and other savers may easily get angry when their savings are being sacrificed for an abstract unnamed “common good”.

The resulting official solution is a gradual “voluntary” private sector forgiveness of Greece’s debts until the total debt burden comes down to the “sustainable levels”:
* In Q2 2011 eurozone banks had to take a 21% loss for Greek bonds with maturities before or in 2020 (source: banks’ financial statements);
* The restructurings of private debt early 2012 effectively reduced Greece’s debts by 30% of GDP, otherwise it would have been above 200% by now (source: Wikipedia);
* Under the new 26/27 November 2012 agreement, around 20-25 bln euros of bonds will be “forgiven” in the frame of debt buyback clause.
In addition, as official sector contribution, the Eurosystem has basically agreed to give up its profits on Greece’s bonds (via lowering interest rates and guarantee fee costs for Greece as well as via extending its loan maturities and deferring its interest payments).

Reaching such voluntary agreements with private creditors would be impressive if these indeed would classify as charity. But they don’t; it’s still all about politics and business.   

Apparently, none of these write-offs has been voluntary but under the implicit or explicit pressure in style: “If you don’t agree, something even worse would happen.” As an example, here is an excerpt from the 10 December 2012 press release of Greece’s Ministry of Finance (after it had failed to attract enough interest to its respective 3 December 2012 announcement): “Future measures may not involve an opportunity to exit investments in Designated Securities at the levels offered for this buy back.”

Furthermore, these are the very own Greek banks on government support that have taken a large part of the losses so far. Reportedly, they are taking the losses in the hope of future public aid. Some observers argue that forcing Greece’s banks to take losses first is a major stupidity. Namely, under the so-called collective action clauses, if 2/3 of the Greece’s bond holders would have voted “for”, everyone else had to agree with the decision under the clause. The required 2/3 would have consisted of Greek banks and certain hedge funds that wanted to lock their profits from a few weeks’ rally in Greek bond prices; the remaining 1/3 would have included everyone else holding qualifying bonds. This way more debts could have been written off than under the current arrangement.  Now Greek banks have given up more-less everything with no claims towards external creditors.

Even more: the IMF and Eurogroup welcomed 124% debt-to-GDP ratio doesn’t look at all like a sustainable level for Greece. For one thing, the magic 120% ratio by 2020 has been announced more than once, but still failed so far. Secondly, this very number, the targeted 120% or 124%, is purely subjective based on an argument that once upon a time a country managed to bring down its debt from that level...; no one guarantees that it’s actually sustainable. Indeed, in 2010 Greece failed at 129.7% Government debt / GDP ratio. How can it succeed at 124% level?


Summary

There is a short summary to the long story: the story is getting even longer as Greece’s debacle will most probably continue. The “litmus test” is still not finished. So far, policy makers deserve a “prize” for “kicking the can” unbelievably far “down the road”, but that’s basically it.

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