Yesterday Sunday the 2nd of May saw some significant changes in the likely financial future of Greece and by implication also the euro zone and the International Monetary Fund (IMF). I rather suspect that these matters will be debated for some time as I can already see implications both intended and unintended which stretch into the future. Sadly this future includes the period after the term of this aid package. The details which came out gradually through the day (has no-one told these people that you look more efficient and competent if you realise it all as one package?). In terms of details we got an austerity package for Greece which is estimated at 30 billion Euros in terms of size (more than the 24 billion trailed) and a combined euro zone/IMF aid package of 110 billion Euros (less than the 120 billion leaked at the Bundestag last week).
Greece’s Austerity Package
The Greek government has released a summary of the austerity measures which it will now impose as part of the conditions imposed by the euro zone and the IMF.
1. The 13th and 14th month salaries for public employees will be eliminated for those earning over 3000 Euros a month and capped at 1000 Euros for those earning less than this.
2.In addition, public sector salaries will be frozen until 2014 and allowances (another income stream for public employees) will be chopped by 8% which in fact is in addition to the 12% announced by Greece’s own austerity programme announced earlier this year.
3. The 13th and 14th “holiday” payments to pensioners will be reduced by an amount which is estimated to save 1.5 billion euros in 2010.
4. Public investment plans will be cut by 500 million Euros in 2010.
1.The main VAT rate will increase by 2% to 23% which adds to the increase announced in March of 2% to 21% and excise taxes on fuel, tobacco and alcohol will increase by another 10% as they too were also raised in March.
2. There will be new taxes on properties and the gaming industries; Private companies will have to pay a one-off tax on 2009 profits which will be as well as a similar levy six months ago on profits from the previous year.
There are some planned structural policies to try to increase Greece’s growth rate. These include a liberalisation of labour markets by ending the current law which stops companies from laying off more than 2% of their workforce each month. There is a plan to liberalise the energy and transportation sectors. The state pension system will also be modified with rises in the pension age which may well be linked to life expectancy and increases in the level of contributions to the scheme.Also it will switch to a career average rather than a final salary type structure.
The Impact of this
This is a severe and deflationary package and the official forecast for economic growth over this period is that Gross Domestic Product will shrink by 4.0% this year, which will be followed by a further shrinking of 2.6% next year, and then there will be actual growth of +1.1% in 2012 and +2.1% in each of 2013 and 2014. Should this (rather fanciful) scenario actually take place then Greece’s ratio of national debt to GDP will peak in 2013 at 149%, and will then decline to 144.3% in 2014. Even under this rose-tinted forecast there are disturbing implications for this level of national debt and I shall return to these later.
The implied levels for the fiscal deficit have it falling from 13.6% of GDP last year to 8.1% of GDP this year,and then 7.6% in 2011, and then 6.5% in 2012, 4.9% in 2013 and 2.6% by 2014.
There are several things obvious from these numbers that are clear to me.
1. The forecasts for economic growth are very optimistic. I was expecting Greece’s GDP to fall by 4% this year before these new austerity measures were implemented and I would not have been surprised to see a 2/3 % fall next year. These were already numbers which if they turned out to be wrong would have been on the low side I feel. With the new austerity measure I think that Greece’s economy could contract by 6% this year and by 4% next.
2. Even with these very optimistic forecasts Greece’s ratio of national debt to GDP is expected to peak at 149% of GDP. This is a high figure and means that to finance her debt her economy will have to grow at 1.5 times the interest rate she is charged on her debt to stop her situation deteriorating . I would just like to say that this is just to stop it deteriorating as there is no mention of any improvement for this to take place she would have to grow more quickly.
3. A sign of how dependent these numbers are on rates of economic growth (which sadly in this case are contractions rather than increases) is that Greece’s fiscal deficit under the new austerity plan is forecast to fall below 3% one year later than under the EU/Greek plan announced earlier this year. The factor which has changed is that growth forecasts have deteriorated and this means that in terms of a fiscal deficit flight path even increased austerity measures cannot fill the gap.
4. Now if you put my more realistic forecasts for economic growth into the national and fiscal deficit forecasts above I think you can come to only one conclusion. At the end of this plan Greece is likely to be insolvent.
It is not impossible that Greece will escape this conclusion just very unlikely. After all someone might in the next couple of years discover a way of actually creating power by cold nuclear fusion and thus boost the whole world economy. But under this plan something like that will be required. In essence yet again reality is being postponed and delayed rather than changed.
The EU and IMF
In return for the plan proposed above then Greece will receive around 80 billion Euros of loans from her euro zone partners and 30 billion euros from the IMF. This is a lower amount than trailed and is some 25 billion Euros less than I thought would be necessary as I feel that if you have what is in effect an ammunition store you must never let the prospect arise that it might run out. Imagine the chaos if such a situation did play out.
The state of Greece’s banking sector
Something must be very wrong and it is quite possible that I have underestimated the implications when I wrote on the about the way that Greek banks looked in trouble on the 19th and 28th of April. You see the aid package has two features which make me think this.
1. Euro zone officials said that €10bn of the package could be used as a potential stability fund for the financial sector in particular.
2. The European Central Bank (ECB) said on this morning (Monday the 3rd May) that it was suspending the minimum credit rating required for Greek government-backed assets used in ECB liquidity-providing operations “until further notice”. The move removes the risk of Greek government bonds being excluded from being able to be used as collateral for (cheap) loans from the ECB if ratings agencies should downgrade her status further.
Taking as a whole these are very revealing measures and suggest that the situation may well have been rather dire. Otherwise why do this?
Not only Greek banks will be helped as remember French and German banks in particular were holders of Greek assets/debt on a substantial scale.
This is another loss of credibility for the ECB as it had an opportunity to change its collateral rules only a fortnight ago and did not take it. So it cannot avoid the accusation of a short-term “panic” measure.
I have written before about how the role of the IMF is being changed by this crisis and would refer you to my question posed on the 26th April . However whilst its size is being expanded its role has also changed. If you look at its website it has a factsheet explaining its role.
A member country may request IMF financial assistance if it has a balance of payments need—that is, if it cannot find sufficient financing on affordable terms to meet its net international payments while maintaining adequate reserve buffers going forward. An IMF loan provides a cushion that eases the adjustment policies and reforms that a country must make to correct its balance of payments problem and restore conditions for strong economic growth
Greece does have a balance of payments problem but I doubt if there is a single sane person who believes that is its main current problem so we have one more change from the crisis a new (politically convenient) role for the IMF.
The measures presented above do help Greece with her current liquidity crisis. But as I have described above they do not help her with her solvency problem. Should her economic growth disappoint over the next 2/3 years, and there are grounds for supposing that they will, then this package will make her position worse and she will be less solvent at the end than at the beginning.
For all the rules which are being ignored or watered down leading to a decrease in credibility for the EU nad its institutions I do not feel that this will prove to be a good trade-off.
The actual implementation of all of this has its own risks. As of the end of last week only Cyprus had made real strides in terms of actually approving its share of the proposed loan for Greece. So again action has lagged talk. This is before we see the inevitable submission of this aid package to the German Constitutional Court or perhaps what view the electors of North Rhine Westphalia express on the 9th May. Of course now the plan is larger than the one which not a lot of progress was being made on…
The weaker nations in the euro zone will have to contribute to this package and this will lead to a deterioration in their position. I am particularly thinking of Portugal and Ireland here but they are not alone.