Greek debt is already twice the limit imposed by the
Maastricht Treaty. What happens next? Simon Wilson reports.
What’s happening in Greece?
The country’s latest problems began in October when the
new Socialist government discovered a fiscal deficit of 12.7% of GDP. That’s
more than twice the level declared by the previous government and four times
the 3% ceiling imposed by the EU. Even by Greek standards (it is no stranger to
dodgy statistics), its current fiscal mess came as a surprise, spooking the
ratings agencies and debt markets. In the midst of the country’s first
recession for 16 years, government debt is forecast to be over 100% of GDP this
year (the Maastricht Treaty limit is 60%) making this the most indebted of the
16 eurozone economies.
How has this affected the euro?
Badly. The currency touched seven-month lows below $1.40
early this week, following the most sustained run of bearish sentiment since
the collapse of Lehman Brothers in September 2008. Since early December, the
European currency is down 8% on the dollar, and has even weakened 4% against
the (otherwise struggling) pound sterling. Although there’s every chance of a
short-term recovery, the main cause of the slide is not about to go away – mounting
fears over how Greece’s
problems might affect stability in the rest of the 16-nation eurozone.
Do the Greeks have a plan?
Austerity measures are aimed at cutting the deficit back
to 3% of GDP by 2012. But they imply a massive and radical reform of the
private and public sectors far beyond anything the country has ever known. The
new Greek PM George Papandreou and his finance minster certainly talked a good
game at Davos last week. According to Anatole Kaletsky, writing in The Times,
the pair conveyed a “very favourable impression of competence and honesty” and
a determination to push through “profound reforms of Greek society and
politics, not just some juggling with statistics”.
For now, debt markets are
swallowing the positive talk: Greece got away a €8bn bond issue last week. But that can’t mask the fact that yields on Greek government bonds have soared to more than 7%– a record 400 basis point spread over German bunds. And although the EC recently endorsed Greece’s latest debt-reduction proposals, markets are still buzzing with talk of an EU/IMF
bail-out, and even the prospect of Greece being forced out of the eurozone.
Would that help?
No. Sure, a radical currency depreciation might stimulate
growth by initially making exports cheaper. Meanwhile, a national central bank
could shrink the deficit by inflating it away and/or printing drachmas to buy
government bonds. But equally, abandoning the euro could very easily make Greece’s
problems worse, as economic historian Barry Eichengreen argued in a recent
paper for the IMF. Since overseas borrowings would still be denominated in
euros, any heavily indebted country leaving the euro would find its debt
rising. And the rush of investors trying to get their money out would be likely
to trigger all-out financial collapse. No wonder the new government in Athens has ruled out
leaving.
Could Greece be bailed out?
Officially, all talk of bail-outs is pooh-poohed by Brussels. For starters,
there is no mechanism in place for the European Central Bank or any other EU
body to organise one. The IMF has stated it would be ready to help if the EU
cannot or will not. In practice, however, the rest of the eurozone cannot
afford to let any member state default and will be loathe to allow an IMF
bail-out, since it would wreck the credibility of the single currency and ramp
up the pressure on the next most fiscally exposed states – namely, Spain, Portugal
and Ireland.
Analysts predict that, one way or another, the EU – and in particular Germany and France
– will help Greece
cope with its financial problems. For example, Pierre Briancon on Breakingviews
believes that, “whether aid comes in the form of bilateral loans, or via
special facilities that are possible under the existing treaties”, Athens will not be left
out in the cold.
How does this affect investors?
It throws up new challenges. Three years ago it was
unthinkable that a major global bank could go bust; today it might seem
unthinkable that a major government could do so. But due to the global
financial crisis, governments’ borrowings have ballooned. Greece is a
reminder of why fears of national defaults will remain crucial to investor
thinking. As Mohamed El-Erian, chief executive of Pimco, put it in the FT: any
solution to the Greek problem is “unlikely to be sustained” and markets will
remain volatile. Greece also flags up a new set of worries for investors trying to manage international
portfolio risk. In short, “sovereign balance sheets in many advanced economies
are now in play”.
What next for Greece?
Last year a combination of students, leftists and
anarchists triggered Greece’s
worst riots in decades. Fortunately, the new PASOK (Socialist) government
enjoys strong popular support. But Prime Minister George Papandreou’s
cost-slashing and tax-hiking plans already face opposition within his own party
and among labour unions. The two biggest unions have announced 24-hour strikes
later this month. Meanwhile, Greece’s
most influential think-tank warns that more social unrest beckons as the
austerity measures bite. That would further sour investor sentiment, especially
if markets fear the government might water down its attempts to conquer Greek
debt.