Press reports have suggested that the International Monetary Fund has become unhappy with the Greek government’s austerity measures, since it felt not enough was being done to maintain fiscal solvency. Anyhow the latest tranche of money has been credited to the Greek government and life goes on, although Greece’s international creditors are watching the budget numbers month by month. The following note recognises that the Greek government is not far from achieving a ‘primary budget balance’ (i.e., non-interest public expenditure is only slightly above tax revenues). In that sense, much has been done to restore the creditworthiness of the Greek state. However, the cost has been calamitous, with falls of about a quarter in real terms in both national output and government expenditure. Even worse, it is not clear that the big austerity drive so far will be sufficient. Two points have to be emphasized. First, output has fallen so heavily from the peak (i.e., in 2007), and is still falling at such a rate, that a budget surplus would be needed to stop the debt/to/GDP ratio from rising further. There is no sign of that. Despite the defaults to private sector creditors, IMF data show the debt-to-GDP ratio now at about 175%. Second, the drop in output has of course a large cyclical element and, sooner or later, a cyclical recovery must surely happen. However, a deeper problem is now emerging, that international investors are shunning Greece and the trend level of output may be going down. To halt the rise in the debt-to-GDP ratio, Greece therefore needs an overall budget surplus over a series of years and not just a primary surplus in an emergency period Again, there is no prospect of that in any relevant planning horizon.
The Eurozone resembles a vast dyke which is full of holes and liable to disintegrate at any moment. This note concentrates on Portugal, where the recent resignation of the very able finance minister, Vitor Gaspar, was a huge disappointment. (It must be said that the Eurozone’s holes in Greece, Spain, Italy and France also remain large and conspicuous, despite international officialdom’s attempts to patch them.) Portugal’s problems arise partly because the economy’s trend rate of growth is now very low, perhaps even zero or negative. Gross domestic product per head is lower than ten years ago. With inflation almost zero, nominal GDP is at best flat. As a result, any deficit leads to an increase in the ratio of public debt to GDP. A May 2011 bailout negotiation with the ‘troika’ extended €78b. of loan and other financing, to help the Portuguese government and banking system. It must be acknowledged that Portugal has tried hard, with Gaspar at the finance ministry, to meet the conditions attached to the bailout plan. The cyclically-adjusted budget deficit fell from 9.0% in 2010 to 4.0% in 2012. Nevertheless, the debt-to-GDP ratio has kept on rising and is now over 120%, the kind of figure that was associated with the Greek dégringolade in 2012. (A fair verdict is that a debt-to-GDP ratio of 120% is sustainable when the nominal interest rate on the debt is 5% or less, but – once the interest rate goes into double digits – the debt interest burden runs amok like a Frankenstein monster.) The Portuguese people are apparently weary with austerity, and it has to be said that – without a resumption of growth and particularly of asset price appreciation, which would help banking solvency – the danger has to be that further deficit-reduction measures would not restore fiscal sustainability or national solvency. Holders of Portuguese banks’ bond liabilities and depositors with Portugal’s banks, you have been warned! PEXIT (Portuguese exit from the Eurozone) is – almost certainly – a better option than staying in.
The Greek government recorded a surplus on its finances in January, an apparently heartening development in the continuing Eurozone melodrama. The surplus was the result of huge cuts in expenditure combined with the seasonal pattern of tax payments, which has the effect of making January a month of unusually high tax receipts in every financial year. (Greece had a budget surplus in January 2010, also.) Key decisions on Greek public finances are now being taken by the troika, the group of international bodies (the International Monetary Fund, the European Commission and the European Central Bank) acting more or less in unison to ensure that financially distressed Eurozone countries can honour (some of) their international debts. Can these organizations at last start celebrating? Is austerity having the desired effects? In fact, the wider macroeconomic background in Greece remains appalling. The January outturn is unsustainable, and reflects both desperation and severe fiscal trauma. Needs must when the troika drives. Tax revenues were lower, by over 9%, in January 2013 than a year earlier. The surplus was ‘achieved’ only by a fall of over 20% in expenditure, from €5,362m. in January 2012 to €4,239m. last month. It should also be emphasized that in January 2011 expenditure was €8,408m. In other words, Greek government expenditure at the start of 2013 was half (yes!) the level of two years ago. The Greek state is having difficulty controlling its borders, with immigrants widely reported to be responsible for a crime wave. There is still a high risk that Greece and/or Cyprus will leave the Eurozone.
Since 2009 Greece has been a barometer of the Eurozone’s continued viability. The rake’s progress of the four years to early 2009 had been remarkable. It had run current account deficits (relative to GDP) of 7.6% in 2005, 11.4% in 2006, 14.6% in 2007 and 14.9% in 2008 or, over the four years combined, of about 50% of GDP. The big external creditors included international banks, particularly European banks, which had acquired large holdings of Greek government debt and made loans to Greek banks. The extra debt could be serviced in the long run only if Greece reduced its current account deficit substantially. A devaluation against the currencies of its main trading partners was therefore sensible, in order to motivate the necessary switch of production towards exports. Unfortunately, as a member of the Eurozone single currency area Greece could not devalue. It could leave the Eurozone, but that would shatter the geopolitical dreams of the Eurozone’s architects in Germany and France. For them the single currency area was a permanent structure which foreshadowed ever-increasing economic and political integration in the European Union. As devaluation within the Eurozone was impossible, the focus of the policy drive to improve Greece’s financial position was on the budget deficit. The Eurozone sovereign debt crisis escalated in early 2010. Since then negotiations have been held between international bodies (usually “the troika” of the European Commission, the European Central Bank and the International Monetary Fund) and the Greek authorities, about targets for the reduction of budget deficits and public debt. The Greeks have repeatedly missed the targets. Fiscal austerity and the implosion of the banking system have been associated with a drop in real GDP of almost a quarter in five years. The GDP decline has further pushed up the debt/GDP ratio. This note examines the latest developments. Although the budget deficit numbers have been better in 2012 than in 2011, the macroeconomic trauma is so severe and unrelenting that Greece must leave the single currency area as soon as possible.
Some clients have been puzzled by my suggestion last week that the Greek government could go bust, and that Greece could still remain in the Eurozone and keep the euro as its currency. Actually, a government bankruptcy is much easier to reconcile with Greece retaining the euro than a banking system bankruptcy. In this week’s note I look at the consequences of a generalized banking system insolvency for Greece’s position in the Eurozone. I accept that – if Greece’s banks cannot meet their obligations in inter-bank settlement – the temptation to bring back the drachma may be overwhelming. (Professor John Whittaker of Lancaster University Business School has pointed out that – if Greek banks no longer have a positive balance in their cash reserve with the ECB – they cannot cover a deficiency in cash flows arising from customer instructions. Whittaker’s observation is compelling if depositors withdraw cash from Greek banks in ‘a run’. Indeed, I discussed that possibility in a weekly e-mail of 26th February 2010, with the key passage an appendix at the end of this note.) However, it must be remembered that Greece continues to receive large amounts of money – for farming and regional development – from the European Union. It seems to me that Greece will try to keep the euro even when both its government and banks are ‘bust’. I am not saying it will succeed in keeping the euro. I don’t know and I am pretty sure the key policy- makers are just as uncertain as I am. If Greece does keep the euro, there is a high possibility that Greek banks will be unable to repay deposits in full, perhaps for an extended period.
Recent reports in the newspapers suggest that the Greek budget deficit might be 8½% - 9% of GDP in 2011, above the target of 7½% or so agreed with the IMF and the EU, but within striking distance of it. In fact, the data available so far indicate that the deficit is heading for about 15% of GDP, although this might be an over-estimate if the closing months of 2011 see immense receipts from privatisations. Assuming that privatisation receipts are negligible (which is reasonably in the current traumatic environment), Greece’s budget deficit is like to be about double the target agreed in last year’s bail-out package. Greece cannot be allowed any more wiggle room. But, because cutbacks in government spending (i.e., a tighter fiscal policy) cannot be offset by an easier monetary policy, attempts to slash the budget deficit are counter-productive. The debt is rising remorselessly towards 175% - 200% of GDP, while the market interest rate on new and maturing public debt is far into the double digits. Greece is completely bust and beyond rescue.
Financial crises in the Eurozone periphery are being accompanied by regulatory demands that banks have more capital and shrink their assets, along with reinforced fiscal stringency. So Eurozone M3 – which saw a resumption of growth in summer and autumn 2010 – has stagnated again in the last few months. (M3 was 9,302b. euros in January 2010 and 9,522b. euros in August 2010, implying an annualised growth rate in the seven months of 4.1%. In February 2011 it was 9,543b. euros, barely higher than six months earlier. Last week’s e-mail showed how Ireland’s money supply crashed in 2010, even while banks in other Eurozone countries were expanding their balance sheets. The official pressures on banks in the peripheral countries [i.e., the ‘PIGS’, Portugal, Ireland, Greece and Spain] to raise capital and sell of loan portfolios are clearly a major factor in the latest money slowdown. Because of the recent oil and commodity price surge, real money balances have been falling since autumn 2010. This fall has been most pronounced in the peripheral countries, and is negative for demand and output in their economies this year.) But demand pointers for the Eurozone as a whole, such as leading indicator indices, are satisfactory, even good. The messages have to be that the divergence in macro conditions between the core and periphery will widen in the rest of 2011, putting further strain on the Eurozone’s integrity, and ii. although German export strength may continue, the Eurozone economy will face a monetary headwind in spring 2011. A weakening in business activity would have been likely even before the ECB’s rate rise. The risk of a pause in the Eurozone’s recovery has been increased by the fall in the dollar against the euro, which has advanced since early January from roughly $1.30 to almost $1.45. The euro’s advance, of about 10% or so, seems difficult to justify by the change in interest rate differentials.