After asking for more clarity on plans for cutting the UK’s fiscal deficit from the three men who would be our Prime Minister in their televised debate yesterday I hoped for it but in all honesty did not expect it. In the circumstances it was no great surprise that all three of them ducked the issue and flunked their chance. There was no new insight and yet again the debate swirled around the Conservatives planned reduction in Labour’s National Insurance increase that will come into effect in 2011. As I pointed out yesterday we have a £163 billion a year problem and all our politicians talk about is a measure which costs £6 billion a year. I am not saying that £6 billion is a small amount, plainly it is not, but on the scale of decisions facing the new or re-elected government it is relatively small.So on the real issue there simply has been no real debate. If you look at it in terms of mandate when whoever occupies the position of Prime Minister on May 7th starts the required austerity measures they will not have a mandate to do it.
I noticed an interesting point in the comments section of the Financial Times and repeat it here
The modern career politician wants to BE something, not to DO something. To that end, they will say anything they have to say, and do anything they have to do to, and any problems they face in office are a bridge to be crossed when they come to it. A term in the hand is worth a dynasty in the bush.
The saddest part is that I cannot say that this point of view looks wrong…
Sir John Gieve
In case you do not know who this man is he was the Deputy Governor of the Bank of England and a member of the Monetary Policy Committee. He is what you might call an “insider” and this week gave an interesting speech. For example he does not think much of the election debate either
Everyone’s saying they will do everything that is necessary but they are not spelling out how draconian some of these are going to feel on the ground
However then he referred to the issue of independence of the Monetary Policy Committee
There’s no reason why you should not try to fill that out through some sort of meeting in which the Bank, the Treasury and the Financial Services Authority get together and discuss sequencing and what order you are going to do it in. The Monetary Policy Committee is still independent in judging whether you are on track.
I disagree as in my view you cannot be partly independent, it is something you have or not. Also the very fact that an “insider” talks about such a thing (and is looking for more of what he calls co-operation) pretty much speaks for itself as to the current state of play.
As to the supposed claims about the Governor of the Bank of England and his supposed statement that whoever wins the next election may face a poisoned chalice and may accordingly find themselves in the political wilderness. Is it really such a shock? I do not mean if he said it or not I mean the idea. The next five years are likely to be very difficult and personally I thought the same in the US Presidential election that the winner (who turned out to be Barack Obama) would do very well to avoid being a one term President.
The Greek Problem
We seem finally to be approaching the point where Europe’s leaders will actually activate their plan to aid Greece and it is not before time. Frankly it is certainly two months late at best as I have remarked many times during this crisis. However as Europe’s politicians have been so ineffective it is good to see the International Monetary Fund involving itself in this issue and her President gave the German Parliament an indication of what we can expect this week.
A proposed package
Leaks suggest that Greece will get an aid package of between 100 and 120 million Euros. It is hoped that this will mean that she will not have to borrow on financial markets for three years. Should it turn out to be so then Greece will be able to borrow over the next 3 years at a maximum interest rate of 5% which is much better than financial markets would currently provide evn after yesterdays rally.
Yesterday the Greek Prime Minister meet with Greece’s trade unions and requested their support for an austerity package amounting to 24 billion Euros. Taxes would rise with Value Added Tax going up ( to either 23% or 25%) and fuel alcohol and tobacco taxes rising by 10%. All of these taxes have already been raised once this year. On the spending side we will see the end to the 13th and 14th salary payments that is the Greek custom ( they have 14 rather than the usual 12), a reduction in supplements to state sector salaries. There may be others and the comments section on this site have been illuminated by views and rumours coming from inside Greece herself.
One thing that is sure is this is going to be a real squeeze, it will be harsh and austere and I will return to this later.
Comment and Analysis
It would appear that finally a fund is being put together that approaches the size of Greece’s problems over the next 3 years. However there is still some debate over whether 100 or 120 billion Euros will be the size. Let me give my opinion, Greece has heavy borrowing years planned for 2011 and 2012 so it should be larger of the two and I would have trebled the original plan to 135 billion Euros. As I have mentioned before this is not going to be a period in which running out of ammunition is going to look an attractive scenario should it happen.
When this crisis began I felt that it would be better not to involve the IMF as I felt that it would have plenty of other calls on its resources and as Greece is only around 2.7% of the euro zone in terms of economic size so it should have been containable by Europe’s leaders. I was unaware at that time that my already low view of Europe’s politicians was to be downgraded as fast as Greece’s financial status. Their dithering has turned a containable situation into a crisis that leaves not only Greece facing a period of (even more) severe financial adjustment and all that entails it also questions the future of the Euro project itself.
It would appear that the IMF is now taking a higher role in this crisis and this is now wellcome as the EU has proved unfit for the task. However it is still not absolutely clear that it has the primacy I have called for. It should be given it immediately. Also another disturbing rumour is doing the rounds and as it appears to come from the Head of the IMF I shall repeat it. IMF loans will be junior to those of existing bondholders. This is very significant and I would like to remind readers of my question to you on Monday 26th April
I have a question for my readers here and it relates to the recent increase in loan capital for the IMF. This was announced to great fanfare at the April 2009 G20 meeting by the UK Prime Minister Gordon Brown. He announced it as if it was a rabbit from a hat. However there are potential implication from it, for example what would happen if some of the money was lent and the loan was not repaid? Who is then liable? Has there in any country been a debate on this?
Well making the loans junior to existing bondholders certainly increases the chance of it losing money so where do the losses go if it does? Just to be clear the IMF’s usual terms involve it being paid out first. This is a technical factor that many may miss but it is very important as this crisis is full of events which have not happened before.
The Banking Sector
I have written this week about problems for Europe’s banking sector and there are more and more signs that it is struggling with this crisis. Anybody looking at Greece’s banks must be wondering how much the fall in Greek government bond prices has affected them . Other banks around Europe (if the official figures are accurate particularly in France) must have losses too. It would appear that this is now affecting interbank lending and according to the FT many banks are now shut out of this market. Another sign of such problems is that the yields on German 3 month Treasury Bills are now only 0.19% . This starting to sound reminiscent of what happened to US Treasury Bills after the Lehman crisis.
I have commented on the fact that we can use Latvia to gain some insight into what might now happen to Greece and my main article on this was on the . In December 2008 Latvia called in the IMF because of her fiscal and balance of payments problems and agreed an austerity plan with the IMF. I quote some details below from an article on this at that time from the Latvia Economy Watch. They may look rather familiar.
In return for the loan the IMF have agreed a “strong package of policy measures” with the Latvian government and these will involve sharp cuts in public sector salaries, and a tight control on Latvian fiscal policy. The IMF have insisted on a substantial tightening of fiscal policy: the government is aiming for a headline fiscal deficit of less that 5 percent of GDP in 2009 (compared with an anticipated deficit of 12 percent of GDP in the absence of new measures) – to be reduced to 3% in 2010 (thus the Latvian economy will face not only tight effective monetary policy in 2010 – via the peg – but also a less accommodating fiscal environment, frankly it is hard to see where the stimulus to economic activity is going to come from here) . Structural reforms and wage reductions will also be implemented, led by the public sector, and VAT will be increased, all with the longer term objective of further strengthening Latvian competitiveness and facilitating the external adjustment. The problem is really how the Latvian population are going to eke it out in the shorter term.
You see in 2009 Latvian GDP then fell by nearly 18%. Now I do not predict this for Greece in the next year as plainly 2009 had its own credit crunch problems but I think you cannot avoid the view that Greece’s GDP will now fall if the planned austerity plan comes in by a substantial amount over the next year.
1. In the poker game I discussed between European and Greek politicians then the Greek government gambled and then capitulated.
2. Euro zone politicians have proved to be inadequate for the task and the more involvement we get from the IMF the better.
3. There are disturbing issues around primacy for the IMF and seniority of its debt. One way of making a bad situation worse would be for the IMF to actually lose money.
4. Portugal’s three-year bonds were still yielding more than 5% yesterday so she still faces a loss on any aid to Greece.
5. There are plenty of rumours and promises but remember any rescue plan still has to go through the majority of euro zone Parliaments and looking at the German situation there still seems to be disagreement there. Even if it passes Germany’s Parliament there is her Constitutional Court. So our relief rally in Greek shares and government bonds has plenty of dangers for it in the days ahead.
6. The proposed plan does address Greece’s liquidity problem but it does not settle her solvency problem. There are still may scenarios in which we come to the end of the three years and Greece’s future still looks insolvent. I still believe that some sort of debt restructuring will be necessary and this only reinforces my concerns about IMF debt possibly being junior to other debt.