“The Greek government has lost all fiscal credibility with the market,” says Lee Hardman of Bank of Tokyo-Mitsubishi. Last week Greece outlined how it planned to cut its huge budget deficit and overall debt load, respectively estimated at 12.7% of GDP in 2009 and 120% of GDP this year. The latter figure could reach 138% if no serious action is taken. In response, the spread between German and Greek government bond yields reached new highs. The gap is 2.7% for ten-year paper, with Greek ten-year yields up by over 1.2% in three months.
An unconvincing plan
The growth forecasts that support the figures look too optimistic and we heard nothing on pension reform, “one of the key areas” threatening the “long-term sustainability” of Greek public finances, says Citigroup. Raising extra revenue, rather than cutting spending, is the overall theme. That’s despite Greece’s ongoing failure over the past few years to control public spending. Deutsche Bank notes that between 2000 and 2008, the public-sector wage bill jumped by 92%.
Not only is the debt load unsustainable in the long-term, but Greece could well have trouble funding itself in the short-term. The country is dependent on foreign investors to buy its debt and needs to raise €53bn this year. “Signs of strain are already emerging”, says Deutsche Bank, with yields on 52-week paper jumping sharply at a debt auction this month.
Greece is trapped
Greece needs to make severe cuts – as Ireland and Latvia have – to bring debt back to sustainable levels. But those countries don’t have Greece’s “powerful trade unions and history of civil unrest”, says Paul Taylor in The New York Times. Yet Greece can’t lower rates or devalue its currency to restore its competitiveness. Only cutting wages will do that in a single-currency zone.
The trouble is austerity is likely to compound the debt problem, says Ambrose Evans-Pritchard in The Daily Telegraph. Even if wage cuts were politically feasible, Greece lacks the “open economy and export sector that may yet save Ireland in similar circumstances”. Tax revenues would “collapse” and debt rise “on a shrinking economic base”. This is a “textbook deflation trap”. There is only one way out, says Desmond Lachman in the FT. Greece will “have to leave the eurozone”.
But is that realistic? Leaving the euro and starting afresh with a new, devalued currency sounds tempting, but the “financial and political costs outweigh the practical benefits”, says Pierre Briancon on Breakingviews. A major problem is that markets would treat switching euro debt into the new devalued currency “like a default”. The EU, meanwhile, reckons expelling a member state from EMU, or the EU, “would be legally next to impossible”, suggesting the event is still considered unlikely, says FTalphaville.com. “Too much political capital has been spent in the past half century for Euroland to allow an outright breakage,” reckons Stephen Jen of BlueGold Capital.
Will Greek troubles spread?
But a default by Greece could lead to a domino effect, with yields on bonds from other peripheral countries with similar problems, such as Portugal and Spain, soaring. That would make their debt problems even worse. So “a rescue will be mounted” if necessary, says Marco Annunziata of UniCredit. This would presumably involve Germany, where politicians appear split on whether they would ride to the rescue. Whatever happens, stresses and strains in the eurozone are set to mount, denting the euro. Greece “has served as a reminder of the difficulties of running a single currency area, perhaps affecting the euro’s appeal as a potential reserve currency”, says Capital Economics. It sees the euro down at $1.30 by the end of the year.