After announcing her new austerity package yesterday and if implemented it is quite an austerity package, with a planned cut in the public-sector fiscal deficit of 4% of Gross Domestic Product (GDP) this year, Greece looked to Europe for a response. Greece’s Prime Minister George Papandreou said
“We have shown we can take difficult decisions. We are waiting for European support – the other side of the agreement,”
So the game of poker and realpolitik I have discussed previously continues.
Looking at the moves planned then these look sufficient to achieve the objective however I have to introduce an economic concept called ceteris paribus here. But the VAT rise to 21%, the rise in excise taxes and the cuts in civil service pay and retirement pensions look as though they will in themselves affect GDP by 2% which if added to the previous moves amount to a substantial tightening of policy. In itself this is good and European leaders have welcomed it. Greece has promised to do what Europe asked of her.
1. This is the third set of austerity measures in three months. This contrasts poorly with Ireland which managed it in one go and gives the impression that Greece was trying to get away with as little as possible.
2.There are signs already of union militancy with some protests taking place on the streets of Athens during the meeting itself. In addition Adedy, the federation of public sector unions, announced a 24-hour walk-out for March 15. So we will have to see how this continues.
3. I used the phrase ceteris paribus above which means all things being equal. Sadly they are not and these measures will impact on economic output as measured by GDP.There is a real danger of Greece being caught in a downward spiral which goes as follows, austerity measures lead to a fall in GDP which means that the austerity measures need to be increased which means that GDP falls again and so on….
4.Greece has a credibility problem which comes from several areas. Firstly the memory of the misrepresented official statistics will take time to fade. Also the scale of the adjustment is very high and such a level of tightening has rarely been achieved by anyone in the past. Added to this is the fact that up until now Greece has hardly been known for taking difficult fiscal decisions.
Conclusion and Comment
A lot rests on the political will of Mr Papandreou and I wish him well. If I was in charge of an international aid package I would support what he has done and if he implemented it fully I would be willing to ignore the effects of point 3 in the weaknesses as a deflationary spiral would do no-one any good at all. As it is Greece will not grow this year and may not next, imagine the effect of another 2 years of recession. We do not want to put her in a depression-type scenario if we can possibly avoid it.
This was quiet but generally favourable. It is always hard to say if one thing affects equity and currency markets but European equity markets generally rose (although Athens stock indices fell back in the afternoon) and the Euro rallied. Greek ten-year bond yields fell to 6.02% and the spread over the German ten-year bund fell to +2.88%.
In addition other Euro zone countries bond spreads over Germany came in with a particular beneficiary being Portugal. Her ten-year government bond yields are now 4.28% which exceeds Germany’s by 1.14%. At the end of last week these numbers were 4.47% and +1.37%. Perhaps a bottle of port is on its way to Mr.Papandreou, if it isn’t it should be!
Over to you Europe
So far only hot air as ministers have queued up to praise Greece’s efforts but there is no sign yet of the European equivalent of the seventh cavalry riding to Greece’s rescue.
As the country widely considered to be Europe’s paymaster she is the main player. Those who did not read my section yesterday on the German Constitutional Court please do so as it has become an important player whose impact is underappreciated in the UK. This has really hamstrung Germany’s response to this crisis and has led in my view to all sorts of plans being considered like German state banks aiding Greece under government guarantees, in other words it sounds to me as if Chancellor Merkel is desperate to find a plan which would help but so far she cannot find one without being summoned to the Constitutional Court. She must have winced when Ottmar Issing stated that “guarantees” provided by the German government to other German institutions would in his view fail the Court’s test and ruling from 1993. She meets the Greek Prime Minister tomorrow and I would imagine plenty of lawyers will be burning the midnight oil as Europe would love to emerge with a rescue plan.
One interesting fact did come out of Germany and I am grateful to the Financial Times for this. A German official was quoted as saying he considered Greece to be “liquid till the end of March” and that the real challenge would come in April as there is a substantial amount of debt to roll-over in that month (approximately 10 billion Euro’s). You see liquid to the end of March is in fact quiet damning as it means that Greece will not be liquid in April which is only four weeks away!
The Euro’s Flaws
This crisis has hit the fundamental flaws at the heart of the Euro almost head-on. I have commented in my previous articles on this subject that I expected Europe’s politicians to prevaricate and indulge in grandstanding and in this instance they have simultaneously failed to disappoint and disappointed me as even though I forecast such behaviour I still hoped for better. We have to face the real prospect that they cannot find a way to help Greece and that the combination of the Euro constitution having no emergency plan and Germany’s Constitutional Court ruling from 1993 has in fact endgamed them at least for now. In essence so far they have exceeded my low expectations of them!
As time goes by this will impact on the credibility of the Euro more and more. I expect more challenges to it as time goes by and we are increasingly left with the two polar extremes. For I believe that Europe’s politicians will continue to press for more political unity in Europe but the weaknesses in the Euro constitution could also lead to a break-up.
In the short term a real challenge to the Euro is Greece’s threat to go to the International Monetary Fund. If she did it would damage the Euro zone’s credibility. I do not believe such a move in itself would break-up the Euro zone but it would set in train a series of events which might. At this time I believe it is only a threat being used as a bargaining chip but if time goes by with no aid from Europe it could become more than a threat, remember the timetable suggested by the German official above. The clock is ticking…
Breaking News (11am)
Greece has announced an auction of 5 billion Euros of ten-year government bonds today. This leads to two thoughts. One is that she wishes to take advantage of the goodwill created by yesterdays announcement the second is that maybe the German official quoted above let the cat out of the bag about their liquidity position. However both lead to the same conclusion.
The last Greek bond issue was described by quite a few journalists as an immediate success followed by it all going rather pear-shaped. Bond issues take a little while to settle down as market professionals buy expecting to sell on at a profit and we have examples of the last Greek bond issue and the Manchester United bond sale where indigestion has followed a few days later. One thing I am sure of is that Europe’s politicians will be urging their banks to buy so let us see how it unfolds.
Monetary Policy Committee in the UK
I will update later if anything significant comes from their announcement at midday.