Bail-out, Debt (Un)-Sustainability Analysis for Greece: where are we in the Crisis Resolution?

Another marathon session in Brussels and, as expected, Greece got the 2012 bail out.  Talk of a possible Greek default through a refusal by the donors to cough up proved to be hot air.

As argued in my earlier blogs, the brinkmanship was all part of the to-be-expected Intergovernmental  and collegiate nature of Eurozone decision-making and to show national electorates in the donor Eurozone north that their politicians have cojones (as well as substantial tolerance of caffeine for the 13-hour sessions) to defend the budget support/aid flows into Greece at a time of growing angst about domestic growth and austerity in their own economies.

So where are we now?

Well Greece has got the €130bn and a PSI that results in an effective reduction by 50% and a projected creditor take-up of 95%.

Lets start with the Debt Sustainability Analysis paper presented to the Eurozone Group .  Dated 15 February 2012 and jointly authored by the Troika (EC, ECB, IMF) it is notable in its honest frankness about the substantial downside risks ahead. Lets look at the main points before assessing what it means:

1. Growth will be lower in Greece in 2012-13 than previously forecast which in turn means public debt as a share of GDP in 2020 is now expected to higher than the target 120% target by 2020 and as high as 178% before declining thereafter (it is hoped..).
2. There is formal acknowledgement that Greece will require further “official” financing and the range is between €50bn -€245bn, highlighting the uncertainties ahead.
3.  The converse of point 2 is that Greece will remain locked out of access to private flows via capital markets  - both due to its credit fundamentals but also because any new debt will in effect be junior to existing debt . Add to this a revision of costs of bank capitalization by €10bn to €50bn.
4. A re-hash of the first point: an explicit recognition that fiscal compression - to first eliminate the deficit/s and then to run surpluses in order to reduce the debt burden – is at odds with the aim to raise the competitiveness or internal devaluation in Greece since the debt to GDP ratio will actually and initially rise (debt constant but GDP will be lower)
5. Acknowledgement that the ECB’s Securities Market Programme (SMP) which is valued at €282bn and with guestimate €50bn in Greek bond holdings, could be used as one future channel to reduce the exiting debt burden further .

What does this all mean?

1. There is a tacit acknowledgement that Greece is in effect insolvent (ie. including projected revenues from privatisation receipts) and as such will need further bailout/s with a real possibility of total write-off of its external liabilities an increasing probability.
2. The timeframes  for further support will , as until now, be conditional on the iterative step-by-step measures  and further caffeine-fuelled sessions in Brussels, the political machinations of the EU and the emerging Eurozone Fiscal Grouping/Fiscal Compact, the election cycles of the donor Eurozoners and of course the outcome of the Greek elections.
3. In return for the current bail out the official creditors have asked for a de facto EU Convergence-cum-IMF Stabilisation Programme, with the first part for would-be EU-entrants but much harsher. Greece ducked the strict criteria applied to the new entrants in Central and Eastern Europe in 2004 (and which I was involved with and now so in the W.Balkans) and that has partly been the Achilles heel for the rest of the Eurozone Currency Union. The real test will be whether this focus on re-visiting the necessary part of the convergence machinery:   institutional building, regulatory reform eg land registries etc.  as well as liberalisation of service and product markets plus a massive shift in fiscal management on both revenue and expenditure management will carry traction – the key difference with the new EU Member States is that the latter had “ownership” of these reforms as part of the entry ticket to the EU’s Single Market as well as promise of soft transfers through Structural and Cohesion Funding.
4. Although not covered in the Debt Sustainability Analysis, one major worry has to be also the Current Account Deficit and the financing thereof. With outright devaluation not feasible and with little sign that Net Exports will provide sufficient upside, Greece will have a Financing Problem on the External Account. In one sense the reduction of capital flows on the Capital Account will limit the financing capacity and thereby help to negate the problem. That said there will be need of sufficient financing to ensure that the country doesn’t run out of sufficient necessities – at least in the form of energy imports.
5. Credit crunch and the private sector. With a smaller State and Net Exports in doldrums, the private sector has to be the engine. However there is worrying evidence that the sector is compressing  in part due to the credit crunch domestically and also to problems with trade finance across borders.

Summary:  

A lot of imponderables and uncertainties still ahead for Greece and the Eurozone. Whilst the financial markets and asset managers have focus on particular time-frames and returns, from a policy perspective there is real need to shift to a longer-term strategic focus of what is the future of Greece in the EU and the Eurozone.

Exit from the Eurozone (aside from the costs) will still leave Greece in the EU and with existing structural flaws that need address. Within the Eurozone, now, continued and accelerated austerity alone – with a further  envisaged decline in real primary expenditure by 20% up to 2015 is simply not credible in terms of the already fragile social cohesion in Greece (with Syria in flames and the Arab spring not quite bearing fruit this has to be avoided at all cost). Encouraging initiatives emerging out of Germany about a de facto Greek Marshal Fund suggest a good start – and point out another corollary likely to emerge and which will be the focus of the next blog.

Greece and the Euro-crisis: the End-Game or the Beginning of the End?

In an earlier blog on the issue  I concluded that brinkmanship will take us to the edge but that Greece will get the next bail out of €130bn and in turn allow it to meet the March 20th repayment of €14.4bn. This remains my baseline scenario.

Even if the baseline holds, the Sovereign Crisis will by no means be over. The resolution of Greece's external debt overhang will still not be complete and the 120% of GDP target by 2020 that has become a gospel-esque benchmark will require further reduction, particularly against a further deterioration of the economy.

Secondly, as also concluded in the earlier blog, the Crisis is pan-European in nature and as such whatever happens to Greece will affect how economic agents - both debtors, creditors and market participants - assess the probability of replication to other soverigns facing the music.

What has changed in the last two weeks is a growing schism in rhetoric from both sides of the de facto Transfer Union: growing angst among the donor countries whether they are about to throw in good money after bad and whether Greece will be able to comply with the already onerous conditions being imposed. And from the Greeks vociferous complaints about German-fostered austerity and what many there see as de facto colonialism. Elections in Greece are due in April and the polls show an erosion of the centre and toward the extremes on either flank, which raises political risk beyond April.

There is also a gung-ho attitude emerging from the donor north that is now openly airing the possibility of a Greek default and exit from the Euro. This is supposedly premised on the robustness of the new defence lines and safeguards via the EFSF and the ESM.

Sand-castles and Maginot Lines of defence more like...one only hopes that this is gung-ho talk as part of the back-and-forth fine-tuning of conditionalities under the aegis of the Troika (EU, IMF and ECB).

On the other hand we have increasing market chatter of a likely Greek default - in part fed by the statements from Finance Ministry officials in the donor Euro-north - and the likes of John Paulson (Hedge Funder) are forecasting and betting on the total break-up of the Euro.

Put it together and we have the continuing uncertainty and volatility in the markets and in policy circles....now and looking ahead for the rest of 2012.

Why the (messy) status-quo will remain and the Euro won't break up (at least in the near term):

1. The markets - particularly outside the Continent - do not fully appreciate the European mindset that exists not only among the political elite but reflects a general consensus in society for the need of a European framework. The EU is the glue that emerged out of the last World War and has enormous groundswell of support. Its institutional structures will therefore continue to grind forward toward consensus and agreement - it is in the DNA of the EC - but also among the EU Member States.
2. This in turn means that at an operational level the machinery to ensure process and procedure will continue to take its course and which tends to gravitate toward risk-neutral outcomes.
3. The Franco-German axis will continue to set the agenda and neither wants Greece to collapse. Germany has, despite howls of Greek horror, put up massive amounts of capital but understandably wants surety that there will be value-for-money. However Merkel's vision is clearly focussed on imposing German-style fiscal rigour and an incremental approach to the crisis that is not everyone's flavour. A disorderly Greek exit which if followed to its logical conclusion to a collapse of the Eurozone, the return of the DM and it subsequent strengthening would not be in the German economic interest. French president Sarkozy on the other is an election mode and fighting to save his presidency - the last thing he needs is Greece bellying-up, an immediate impact on banks in France and a possible banking crisis and risk to re-election.
4. Firewalls? Yes they exist but do we really want them tested? One lesson from the Banking Crisis has been that number-crunchers tend to always underestimate the true scale of woes and related costs. And the European banking scene  has not really undergone the reparation of balance sheets seen in the US. Remember the "dis-stress tests" by the EBA last year?
5. Not assisting the Greeks is self-defeating as any exit from the Euro will lead to an even bigger economic shock and meltdown there - in the end Greece as an EU Member State will require massive aid flows from the rest of the EU (and which will suck in non Eurozoners like the UK), but its exit would be the canary in the mine that acts as a catalyst on expected attacks on other sovereigns in the Eurozone but also among dodgy CEEs outside the EU (Hungary, Serbia, Romania...), runs on banking systems, a deeper credit crunch and goodbye to fragile signs of growth in the EU and ultimately growth globally. And hit Eurozone Treasuries through the quasi-fiscal liabilities of their share of support to Greece via the ECB.
6. It is in the interests of Greece to sign-off on any demands but the EU will need to start focussing on how to improve the growth prospects and bring a degree of genuine solidarity and ownership. 
7. Supply side reforms will bring benefits in Greece (and in Italy) which in many ways is a transition economy in terms of institutional structures and inter-operability of IT systems in budget planning, execution and financial reporting that have been shown to provide fairly quick wins for the new EU Member States - but standards for which were not strictly applied to Greece during its accession to the EU in 1981 or indeed in terms of the rigour for the benchmarking when Greece submitted its request to join the Eurozone in 2000.

The doomsday scenario is how a disorderly Greek default would amplify pan-country risk and in turn deteriorate already fragile growth trajectories is worth painting out next time. 

Finally, and continuing with the doomsday scenario, were Greece to exit, then I would support the Paulson thesis that we could see a very quick and messy Euro-break up - and far faster than models project. We know when economic or political unions break they can do so very quickly when a point of  inflexion is reached - as anyone who recalls the domino effect of the collapse of the Iron curtain will recall.

Scottish Independence and putative rise in Haggis Country Risk: Fact or Fiction?

I mentioned slightly tongue in check whether the Scottish would-be independents are following the Euro crisis in my piece on the Implications of the Sovereign Debt Crisis in http://rupinder-econ.blogspot.com/2012/01/psi-budget-commissioner-for-greece.html .

The National Institute Economic Review (NIESR) has come out with a review following which the three main rating agencies have echoed what might be best-described as “cautiously  cautious” rather than optimistic or pessimistic – no an independent Scotland would not immediately piggy-back on the UK’s Triple A status.

So does this mean Scotland risks being bunched more with Iceland than Norway? Far fetched.

There’ll be a lot of discussion about what a full-scale divorce from the UK would entail, not least in terms of the splits to the Defence Forces, but if the Soviet Union dissolution could be done in 1991 then political will will take care of this, if it goes that far….which I think nobody really expects. But worth thinking through the policy aspects and potential Country Risk aspects of which there’s been a good deal of hocus-pocus in the last week.

From an economic perspective, key points of interest:

1.       The political part of the political-economy will carry the greater weight in any final outcome and the degree of fiscal autonomy/independence the Scots vote for (depending on the questions..) AND not marginal concern about a potential rating – mentioned in the last couple of days on behalf of the 3 major rating agencies. Recall the IMF giving advice to the 3 Baltics in 1991 not to leave the Ruble zone….yet these countries did exactly that, dumping it for their own currencies and successfully so.

2.       Greater fiscal autonomy via independence will go hand-in-hand with monetary independence. The focus of the Scottish National Party has been to focus on the potential oil-manna and the implied fiscal boon. With their Calvinist tradition of tight money and history of puritan Scottish Banking (recent excesses aka RBS et all excluded) there is no reason why the Scots cannot make a good fist of this – even if there is a starting point of a national debt burden through pro-rata sharing of existing UK-wide liabilities….although the new Scottish Central Bank will want a slice of the Bank of England’s reserves no doubt that will mitigate this in part.

3.       Monetary Policy? Again, harking back to the experience of the Balts or other Soviet legacy States, in principle this should  not be a major concern in terms of the institutional or functional setup. 

4.       Yes there will be interesting questions about whether to peg to the UK pound, the Euro or “do a Montenegro” and have the Euro as the Scottish currency (unlikely), peg it (common model from the GCC to Hong Kong, vis-à-vis the US$), or have their own.  But again, these are secondary technical issues to the real political demand that often drives the drive toward total separation between States  - where it happens...

5.       Two and a half other issues of note going forward for any putative independent Scotland: Taken together, Scotland wouldn’t  have the economic independence of Norway …remember Norway is not an EU Member although it shares many of the advantages through a partnership arrangement with the EU through the European Economic Area…a sort of friendly merger of sorts between the EFTA group of nations that includes Iceland (now bidding to join the EU), Liechtenstein and Norway….that allows them to participate in the EU’s Internal Market but without full-fledged membership. 

a.       Within the EU, the increasing – German led – foisting of co-ordinated economic and fiscal policies will effectively constrain significant deviation of Scottish economic management

b.      A real exchange rate rise will be a given over the coming years which will very quickly translate into a massive surge in the wages of the non-tradeable sector and make the non hydro-carbon sector increasingly uncompetitive, lead to a massive property bubble and bring with it a different set of problems of demand management.

c.       The half point: Hmm would Scotland I wonder become a net payer into the EU Budget ?

    …so perhaps the real test for Scottish independence would be to go the full hog and seek exit from the EU but have a loose link with the EU in the same way Norway does through EFTA…

Mary Poppins and the Eurozone Crisis: will a Spoonful of ECB medicine be enough?

Aside from the historical aberration of the Planned Economy Model in the 20^th century where diktat replaced the invisible hand in directing the allocation of resources and of savings there has been little change in how Financial Intermediation has worked over the last two Millenia.

To a large extent Financial Intermediation has always involved deposit taking banks. And despite the liberalisation of financial markets and the advent of new forms of financial intermediation this remains broadly the case today…as do the risks of bank failure, contagion and the impact on the real sector.

In simple terms a bank pools deposits from individuals or companies and aside from a buffer to meet withdrawal demand, lends the rest…and …in the process creates credit as it can lend a multiple of the original savings. Add in some safety valves such as depositor insurance and a regulatory framework to ensure banks keep adequate capital…and so went banking theory…you could more or limit the risk of both bank failure and bank runs. Especially if you have control over the printing presses…ie you have an independent monetary policy allowing a “lender of last resort” function.

Stability often went hand-in-hand with the psychological elements. So you want a sense of stability with your bank and indeed with your Central Banks...names like Rock…Northern Rock…no just joking…coupled with a sense of age,maturity, stability and plain boringness…although I recall walking into the Central Bank of Estonia in the late 90s for the first time and seeing a totally different take which was more modern art than the stodgy, bulky Stalinist buildings  designed to intimidate citizens and which the Estonians wanted to get away ASAP in their journey from Moscow to Brussels…and now Frankfurt where the ECB is located.

Why stability…well there’s a huge history of bank runs that can start with a depositor run on a single bank. …for a quick multi-media and more enjoyable take see http://www.youtube.com/watch?v=eOi6c3NPYms&feature=related for the excerpt from Mary Poppins and how it can all start….

OK, fast forward to 2012…..and to the Eurozone, the banking sector, the role of the ECB and Emerging Economies in Europe.

Starting point and not really a point of contention now: the sovereign and banking crisis are intertwined (this at least differed during the Bullion era where sovereign crisis were country-specific).

What was perhaps less appreciated at the outset has been the potential spillover of the financial crisis into the real economies  - particularly the debt-fuelled private sectors in Western Europe and the US (although the signs are that de-leveraging or dis-saving there is much faster as households in particular pay off debt). 

Previous financial crises had not really affected mature banking sectors and hence the transmission to the real sectors was broadly unaffected. Not this time. With banks haemorrhaged initially hit by the collapse of the US housing market and subsequent pressures that led to significant bail outs by governments, and a gradual softening in both the US and Europe, there was a much more pronounced pass-through to credit – particularly for personal and housing sectors.

And then, partly as a result of the EU-wide slowdown, we had a growing realisation of the emerging Sovereign Debt crisis that has been rarely off-screen during the last 18 months, which started in Iceland and then ingulfed the former Celtic Tiger, Ireland, before spreading across the southern flank of the EU.

…and more pain for  banks…many of them with substantial exposures to these economies on the assumption that there was no deviation in Country Risk within the Eurozone…

Leaving aside the institutional and legal aspects of what the ECB can and cannot do, in practical terms what is clear is that the ECB under Super Mario has started to soothe market nerves through a much more active monetary stance in recent months, acting as the de facto lender of last resort – even if the term in heresy if spoken in Germany. In addition to buying Sovereign debt from the struggling PIGS it has more or less managed to solve the liquidity crisis in the banking systems – at least for now - and in particular in the inter-bank markets by allowing banks to borrow, on fairly good terms, for up to 3 years – even for dodgy collateral.

Great! And the real sector.. in the Eurozone? Hmm…still not much happening…. Thus the sudden rush among policy-makers to talk about Growth, how to push banks to lend more to the real sector or even – copying the supposed successes of State Capitalism from China to Brazil – a growing appetite for dirigiste policies of state intervention, Industrial Policy and directed credit...

A quick look at the key points and what I’d regard as real downside risks to the talking the talk in the Eurzone and EU about Growth, and why:

• 1.       ECB: its balance sheet is now heavily exposed to the PIGS which market participants talking about the cost of Greek exist from the Euro do not in my mind fully factor in. Under the existing system of the Eurozone, any hit will be shared out – so this is in effect a Eurozone-wide contingent liability (i.e. any  Ministry of  Finance in the Eurozone should have a number for potential fiscal risks if the worst happens and the cost to their budget). The arguments for the PSI in Greece have rightly touched on why the ECB should not also share the “solidarity” of haircut to its €40n exposure to Greece….so the contingent liability could become real much faster than ancipated…in turn affecting the fiscal positions of the rump Eurozone members should Greece (and/or others in the zone leave the Euro)
• 2.       If Greece exists the Eurozone, then contagion will be instant, with Portugal already in the headlights…..so the costs of Greek default for the ECB will be higher both directly as liquidity support is cranked up to fragile banks and the mark-to-market values of its lending to the sovereigns and banks takes a nosedive.
• 3.       Eurozone Banks: what is clear is that a duality is emerging – good banks not in need of support are depositing at the ECB whilst the weaker banks are the ones hoovering up the liquidity support to plug balance sheets and the ill-timed strengthening of capital requirements in the EU and towards Basle III….ill-timed because right now banks need to be incentivised to lend to support real asset markets, Investment and Consumption …not just financial assets..whilst using the existing interest rate spreads to repair capital (“time inconsistency”  problem for fellow nerd Economists).
• 4.       Systemic overview… the ECB is now the Financial Intermediary…maybe worth another look next time…and it is also the lender of last resort…something wrong here? The ECB is keeping afloat bad banks and helping out distressed Euro Sovereigns. Sustainable? Niet.
• 5.       Depositors…a wall of money has already been heading from, in particular Greece to “safer” northern Eurozone banks and into the real estate in London property market. The big risk…aka “I want my money back” cry from the lad in the Mary Poppins clip above…is that deposit withdrawal rises and there is evidence this is already happening…deposits at the ECB fell €25bn in December…which is likely to mean that the relative problems are greater in the southern Eurozone….and the political risk that the externally imposed austerity could derail if we get to a tipping  point in terms of social cohesion.
• 6.       The December data tells us that banks have a perverse incentive to ...reduce loan books!!...whilst still hunting for additional capital to meet stricter new capitaliation rules. Unsurprisingly lending was down close to €50bn in December in the Eurozone….worth repeating the implication: what this tells us that we have a real and present danger of  a credit crunch, fear of lending, fear of borrowing and a declining propensity to consume…why spend your savings if you might not have job?
• 7.       Historical episodes of bank-runs and contagion form the last 200 years tell us that this can happen very fast. In the 24-7 world of today and a “flat world” the speed would be far faster than in the era of the Gold Standard….and not taking into account innovations such as shorting the market, and computerised trading platforms that could add enormous “overshooting”, volality and pollution across asset markets…..put another way, the transmission channel today is much faster and the multiplier effects greater of a Greek exit….which makes it all the less likely. (see http://rupinder-econ.blogspot.com/2012/01/greek-debt-crisis-key-issues-and-likely.html for a review of key issues re Greece).

dWalking-the-talk for growth-enhancing policies in the Eurzone is going to be a lot more difficult than implied by recent statements. A co-ordinated response within the EU and Eurozone will ultimately bear fruit – in particular through sustained structural adjustment, if and when the sovereign/banking crisis is resolved. In the short term, we should send out for Mary Poppins and ask for a bit more medicine --perhaps in the form of continued sustenance of growth in China/Asia and the US.