Tuesday, December 28, 2010

2011 Worse for Greece than 2010

No doubt 2010 was one of the hardest years ever for Greece. However, 2011 will be worse if one looks at the official projections done by the IMF and the Greek Finance Ministry. Here are some numbers.

 Real GDP is expected to decline by 4.2% in 2010, much worse than the 2.4% it fell in 2009. For 2011, the official forecasts show a decline of another 3%. Only in 2012 will the economy grow again and even then at just 1.1%. According to the program, it will take until 2013 for Greece to reach its pre-crisis nominal GDP of €236 bn – on a real basis, longer.

Inflation in 2010 was 4.6%, also much worse than the 1.3% in 2009. In 2011, inflation will remain at high rates (2.2%), and it is not until 2012 that the inflation will be sustainably lower than the Euro area average in order to accomplish the deflation process needed to restore price competitiveness.

Unemployment was 9.4% in 2009 and it jumped to 12.2% in 2010. Unlike other parameters, unemployment is forecasted to keep growing worse in both 2011 and 2012 with rates of 14.3% and 15%, respectively. This is one area where anecdotal evidence says the forecasts may get it wrong. So many of the people I meet worry that they are on the verge of losing their jobs that my sense is unemployment may end up higher.

When it comes to state finances, there is a continuous improvement forecasted. The deficit fell from 15.4% of GDP in 2009 to 9.4% in 2010, and it is set to fall further to 7.4% in 2011 and then 6.5% in 2012. At that point, spending and revenues will be aligned, with the deficit being driven by interest payments.

The primary deficit (the deficit excluding interest payments) will fall from -3.3% in 2010 to -0.8% in 2011. In 2012, Greece is expected to return to primary surpluses, so it will then start to pay down its debt. In 2012 is also the point when default / restructuring starts to make economic sense given that Greece would be able to lower taxes and/or increase spending if it did not have to pay as much to service its debt.

As for the debt itself, it is expected to go from 127% of GDP in 2009 to 141% in 2010 and 152% in 2011. By 2012, debt is expected to have peaked at 158% although it does not start to decline until 2014 (see also here).

These numbers show that sadly Greece has yet to hit bottom, at least insofar as most of the real economy indicators are concerned (GDP, inflation, unemployment). So the patience required by the Greek public and the resolve required by the Greek state – these will only need to grow in the year to come.

Thursday, December 23, 2010

Credit Ratings Agencies Rethink Greek Debt

Moody’s and Fitch are reviewing their sovereign debt rating for Greece, saying they may further downgrade Greek debt. Standard & Poor’s said it may downgrade Greek debt earlier in December. Are these revisions justified and what do they mean for Greece?

Start with easy question: what do they mean? Right now, very little. Greek bonds are already rated below investment grade according to both Moody’s and Standard & Poor’s; if Fitch also downgrades the bonds to junk, the impact is small. A downgrade usually means higher costs to borrow, but since Greece is not raising funds right now, these costs are theoretical, not real. The burden on the economy is set by interest payments on debt issued, and this is not affected by any changes in the price of current debt (see also my post on spreads).

At the same time, Greece has raised over €10 billion in eight auctions for 13- and 26-week T-bills since May 2010. Yields have been flat in 2010, and they are also close to 2008 levels (but still above pre-2008 levels). In other words, Greece is still taping the short-term debt market at reasonable rates, and this ability has yet to be compromised. 

Now the bigger question: is this downgrade justified? Moody’s cited the higher-than-expected revision in debt statistics; the 2010 shortfall in revenues; and the support that Greece may (or may not) have post 2013. Standard & Poor’s mentioned the new European mechanism for countries in crisis post 2013 which may force bondholders to take losses as a precondition for any rescue package. Fitch underscored “the political will and capacity of the Greek state to carry the measures required by the IMF-EU programme.”

Valid concerns all. But new concerns? Doubtful. Loud protests, 24-hour strikes, social unrest – how can anyone be surprised by these? Little has happened to signal that the government is any less willing to make tough choices. Political will has always been the swing variable and nothing suggests that the will has dissipated at all.

New is the European rescue mechanism post 2013. In theory, the mechanism says that rescue packages may involve some losses for holders of debt. But even if that mechanism – which remains very unclear at this stage and probably will remain so for some time – does not change the fundamental realities of the Greek crisis: Greece’s debt will keep rising until 2012-2013; structural reform that delivers growth is the key ingredient to long-term debt sustainability; and the ability to avoid default rests on the willingness of the markets to lend money to Greece in 2013 when the current support package expires (see here). Little in that basic story has changed.

Sunday, December 19, 2010

The Latest IMF Forecasts for Greece’s Debt

The IMF just released its second review of Greece’s program (here). In the document, the Fund has updated its projections for the trajectory of Greek debt in light of the most recent revisions in deficit and debt statistics conducted by Eurostat in November 2010.

In the May 2010 forecast, the Fund expected Greek debt to start from 133% of GDP in 2010, peak at 149% of GDP in 2012-2013 and then decline to 120% of GDP in 2020. In September 2010, the Fund revised its forecast due to higher inflation and a slower correction in the current account. In September, the IMF forecasted Greek debt to reach 144% of GDP in 2012-2013 before starting to decline to an eventual 111% of GDP in 2010 (see here).

In December 2010, the Fund has increased its 2010 number given the inclusion of new liabilities in the official statistics. The debt-over-GDP ratio starts off at 141% of GDP in 2010 and peaks at 158% of GDP by 2012-2013. By 2020, the IMF expects Greek debt to reach 131% of GDP. So while in its September forecast the IMF saw 2020 debt lower than 2009 levels (111% vs. 115%), it has now reverted back to its original (May) expectation that Greek debt will not reach its 2009 levels until after 2020.

Of course, these are baseline scenarios and looking at the range of forecasts is quite instructive. The IMF runs six scenarios which offer dramatically different outcomes: in the best case (within the scenario parameters), Greece’s debt reaches 91% of GDP in 2020; in the worst, it reaches 192% of GDP in 2012.
The most important variable is economic growth. The baseline projection shows Greek GDP growing at 2.3% a year from 2012 (after the recession ends) to 2020. If GDP grew by one percentage point higher than the baseline, Greece’s debt would fall below 2009 levels by 2016; by 2020, its debt would be a manageable 91% and falling by 9-10 percentage points a year. By contrast, if the economy grew at one percentage point less than the baseline, debt would never fall in the forecast period and would peak at 178% of GDP in 2020.

Besides growth, the other variables are contingent liabilities, interest rates, deflation and a lower primary deficit. Of these, interest rate on new debt and a lower primary deficit make the least different versus the baseline. Contingent liabilities are by far the most crucial: this scenario includes “identified guarantees to public enterprises that remain outside of the general government (for a total of €8 billion), and the state-guaranteed liquidity support of the ECB to the financial system of €55 billion. All privatization proceeds are assumed to be zero under this scenario.” In this scenario, default will be even harder to avoid.

These numbers tell us three things:

First, they highlight that bank health is central to limiting contingent liabilities – if the state has to bear these liabilities, life will get very tough.

Second, they also show that the obsession over spreads – the borrowing cost for Greek debt - is in a way overblown relative to other things that can happen. The average cost for debt is estimated at 5.5% for the forecast period (2010-2020) with new debt costing 6.3%. A scenario where borrowing takes place at 200 bps higher (8.3% vs. 6.3%) makes an impact of 14 percentage points of debt-over-GDP by 2020.

Finally, they remind us that it all comes down to growth. Whether Greece can pay down its debt boils down to whether it can generate growth. Nothing else matters.

Thursday, December 16, 2010

Meet the Protestors

Athens is paralyzed this week by protests, chiefly from employees in state-owned enterprises (SOEs) and particularly those in transportation. People who shut down streets and who complain loudly – you should know these people, not personally of course but in aggregate. Here, then, are the employees in SOEs.

There are 52 SOEs in Greece and, in 1H 2010, they employed about 21,967 people or ~0.5% of all people employed in Greece (four companies did not report employee numbers). Of those, almost half work in two companies, ΕΘΕΛ and ΕΔΙΣΥ, the former being responsible for bus transport, the latter for maintaining the rail network. Add the next five largest companies and they make up 84% of the workforce in SOEs. (Here for some more info)

Since the size distribution is skewed, the government has focused its attention on the 11 largest loss making SOEs. In 2009, these companies generated total revenues of €1.5 billion. They lost, however, €1.7 billion, and their cumulative losses over time amounted to €13 billion. To put these numbers in context, remember that Greece’s 2010 deficit will reach around €22 billion – so annual losses of €1.7 billion make up almost 8% of the country’s annual fiscal deficit. 

SOEs suffer from two problems: too many people and too high a payroll. In 2008, the last year for which we have fully comparable data, the Ministry of Finance noted that employees in SOEs earned on average €38,287 a year versus just €19,147 in the private sector. Even relative to other public sector employees, SOE workers earned almost 50% more. More recent data on (a) the salaries of SOE employees in 1H 2010 and (b) the average hourly cost of labor for the whole country show that this trend has hardly changed since 2008.

These are averages, of course, and they mask significant differences between the SOEs. In ΗΣΑΠ (one of the two metros in Athens), the average salary is €56,554, which is equal and often more than what many of my classmates with advances degrees can expect to earn in the United States. On the low end, the €28.609 earned by employees of TEO (highway company), is still considerably above private sector wages.

Usefully the Ministry of Finance has also published the distribution of earnings. In a sample that covers around 70% of all employees, 10% earned over €48,000 while 17% earned from €39,000 to €48,000. Following that is the majority of the employees – 66% – from €19,000 to €39,000. So 93% of SOE employees earn more than the average private sector salary. Add to that the effective lifelong tenure (at least until recent legislation) of these employees, and these numbers are clearly unsustainable, especially given the poor state of services for the bulk of these SOEs.

Saturday, December 11, 2010

Greece’s Amazing Fiscal Achievement in Perspective

In 2010, Greece will lower its government deficit from 15.4% of GDP to 9.4%. The press routinely criticizes the government for not doing enough, for being too slow to reform or for not collecting enough in taxes. But give the government its due: the fiscal consolidation of six percentage points in 2010 is unprecedented by European standards.

To put Greece’s accomplishment in perspective, I looked at how much other countries have cut their deficits in the past. For comparison, I took the EU members since 1995 (if a country joined after 1995, I only took the years since accession). For every year, I calculated the change in the fiscal position of the government: for example, in 1997, Germany’s government deficit was -2.6% of GDP, while it was -3.3% in 1996. So in 1997, Germany reduced its government deficit by 0.7 percentage points.

Since 1996, there are a total of 269 observations (some data is missing for earlier years). When you look at this entire set, almost half of the observations (126) return a value below 0. So in 47% of cases, a government’s fiscal position got worse in a given year (meaning the deficit rose). Much of that is due to the worsening fiscal position of countries in 2008 and 2009 as the crisis hit; of the 126 observations, 49 occurred in 2008 and 2009.

Now look at the other extreme: there are only eight cases of countries that reduced their deficits by more than 3 percentage points: Sweden (1996), Italy (1997), Finland (2000), Czech Republic (2004), Malta (2004), Denmark (2005), Cyprus (2007) and Hungary (2007). Importantly, in none of these cases was the euro the official currency.

This is, then, the context for the fiscal consolidation of six percentage points that Greece is making in 2010. Obviously, the fact that no other EU country has done this before is in part due to the fact that no other country has let its deficit get so completely out of hand. Still, there are several observations of countries faced with deficits above 5% of GDP even prior to the 2008-2009 crisis. Greece’s challenge, of course, is just beginning and a deficit of 9.4% of GDP is still enormous. But more credit should be given to the fact that the government has pulled off an amazing feat in 2010 – and for that, it deserves praise.

Is Greece Leaving the Euro Good for the Euro?

As Europe continues to cope with a crisis that seems to grow bigger by day, the debate is shifting from “what will Europe do” to be “who will abandon the euro first?” Will the periphery be forced out by the core; or will the center decide that the currency marriage with the profligate and the undisciplined is not worth the hassle?

The case for change is seen daily on newspapers across the world. In crisis, markets buy the currencies they trust and sell those they do not. If the exchange rate is the daily poll on the euro, what a disappointment these two years have been. Against the major currencies, the euro has done poorly. Using the pre-Lehman rate of August 2008 as a basis, by November the euro lost 18.5% versus the Australian dollar, 17% versus the Swiss Franc, 31% versus the Japanese Yen, and 8.8% versus the US dollar. Only versus the British Pound has the euro fared better.

What does this tell us? Obviously, markets do not have faith in the euro, but what is “faith?” In theory, the exchange rate links one currency’s supply and demand for money to another’s. In reality, exchange rates move in response to anything, whether rational or whimsical, hard news or gossip. And of course, there are meddling governments as well who distort currencies. In that randomness, however, there is logic. Logic that says exchange rates track the market’s gut feeling about an economy’s prospects.

The market’s perspective on the euro is really a bet on Germany, France, Italy and Spain – herein lies 77% of the Eurozone’s GDP. Strictly speaking, what happens to Greece (2.6% of GDP), Ireland (1.8%) or Portugal (1.9%) is no big deal. Of course, looking at a country’s share of GDP is not enough. Collapsing countries drag with them banks and financial institutions that are tied to them. Ireland’s gross external position, for example, is greater than Japan’s, although the latter’s economy is 23 times the size of the former’s. Big troubles can come from small countries.

In this context, therefore, the task that Europe faces is only incidentally a currency one. The problem is not that Germany and France and Greece and Ireland share the same currency but that they are interlinked through their banking systems. If the peripheral countries fall, the core will not be able to hold not because there is one currency but because the losses triggered on the core’s banks will have to be offset through a sale of assets or through support from governments.

There are, of course, many other intricacies. Governance to avoid profligacy, the periphery’s ability to grow within a fixed exchange rate system, and the fact that membership in the currency union allowed the periphery to spend in ways it would not have been allowed to with an independent currency. These are all important. But for now, life would hardly be easier for the euro if Greece and a few others left the euro.

Wednesday, December 08, 2010

Is Leaving the Euro Good for Greece?

This is a fair question. I have never been an unqualified supporter of Greek participation in the euro. The benefits that Greece enjoys as member of that currency union, a country can enjoy outside of it. And there are significant costs as well to Greece having the euro. Sensible people ought to look at both.

In the euro, Greece loses control over monetary policy, which means it cannot print money. In turn, this means that it follows the Eurozone monetary policy and that its exchange rate is fixed relative to its Eurozone partners. How important is an independent monetary policy, and how important is exchange rate flexibility?

In normal times, monetary policy can anchor inflation expectations; when markets do not fear that governments will print money to finance deficits, they expect lower inflation. Given that high inflation erodes wealth, undermines investment and impedes transactions, low inflation is a great gift. As John Maynard Keynes wrote, “Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency.” In tough times, monetary policy can also make credit available when the private sector needs it, helping to smoothen the business cycle by shortening the trough.

This is the theory; what about the practice? In fact, Greece saw a secular decline in inflation. In the 1980s, its inflation was 19.5%, but from 1992, as the country began the process to join what eventually became the euro, inflation fell and reached a low point of 2.6% in 1999. In the 2000s, Greece still experienced lower inflation, averaging 3.2%. Even so, that inflation was still high relative to its peers: 2.1% was the inflation rate in the Eurozone.

This mismatch brought about two effects. First, it meant that monetary policy was too loose – nominal interests are set commonly but real interest rates depend on country-specific inflation. Higher than average inflation meant lower than average real interest rates, which led to excessive borrowing. To be fair, Greece’s borrowing binge was caused by a structural mismatch between spending and revenue rather than opportunistic spending due to cheap credit. But cheap credit did not help restrain spending.

Second, higher than average inflation misaligned domestic with international labor costs. Greece buys and sells goods using the euro, but because Greek prices and wages were rising faster than European prices, Greek labor costs grew out of synch with the rest of Europe. Relative to 2000, unit labor costs in the Eurozone were up 27% in 2008; in Greece, they were up 62%. This is the highest internal misalignment of any member of the original Eurozone (Slovakia and Slovenia are worst, but they adopted the euro later).

There was one more benefit that came from the euro: Greece’s borrowing costs fell. From bond yields that were three times as high as Germany’s in the early 1990s, the two cost of borrowing for the two countries was almost identical by 2001. Three reasons explained this. First, as Greece puts its finances in order to adopt the euro, its borrowing costs should fall. Second, creditors faced no currency risk if they were fellow euro members or reduced currency risk if they were not (assuming that the Greek drachma would be less stable that the euro). Third, there was a broader convergence in bond yields in the Euro area – although in theory, debts are national debts, the market treated them as collective debts, at least until 2008 (in retrospect, at least for Greece, they were right – Germany did pick up the tab).

The argument for leaving the euro is that by returning to a drachma, Greece would export its way out of its troubles as have most countries that have achieved a large fiscal consolidation. As the IMF noted in its October 2010 World Economic Outlook, “[the IMF analysis] confirms that a fall in the value of the currency plays a key role in softening the impact of fiscal consolidation on output through the impact on net exports. Without this increase in net exports, the output cost of fiscal consolidation would be roughly twice as large, with output falling by 1 percent instead of 0.5 percent.”

All together, this is a strong case for exiting: fiscal consolidation requires export-led growth; Greek inflation was anchored at first but soon exceeded the Eurozone average; exchange rate stability brought a misalignment in labor costs; and finally, Greece no longer borrows on the coat tails of Germany since the spreads against German bonds have ballooned. So why stay in the euro?

This is a sensible case but ultimately a flawed one. For one, inflation and borrowing costs might seem misaligned now, but they are miles ahead from where they were in the early 1990s. It is quite easy to foresee that outside the Eurozone, Greece could spend a decade coping with double digit inflation rates. And borrowing costs will start reflecting both credit and currency risk, compounding the country’s debt and deficit troubles. Life may seem hard in the euro; it would be much harder outside of it.

What about the exchange rate; won’t Greece grow faster without the euro? My main objection is that people who say that Greece will grow faster with a devalued drachma have decades’ worth of evidence against them. A weak currency in itself is a poor foundation for export-led growth. Greece had a free floating drachma before the euro but with no export-driven industries to show for. Just becoming cheaper only gets you so far.

Take tourism. Greece is losing out not only because it is becoming more expensive (it is) but because its product has not evolved. My parents (who are in tourism) tell me of clients who say, “If I come to Greece, I will go to the same hotels, the same museums, and the same clubs that I went to forty years ago; why come again?” Even in my lifetime, it is easy to see how places like Kuşadası in Turkey have been transformed while Mykonos, Santorini and Crete are offering the same product they did 15 years ago. My point is that there is a lot more to exports than an exchange rate.

This brings me to point number two. Anyone who is familiar with the Greek economy knows there is plenty of slack in the system, courtesy of rigid labor markets and red tape. There are businesses that are not created, products that are not launched, and services that are not offered because there are too many barriers in the way. It rarely pays to try big things in Greece. This is where Greece’s growth should come from – and it is Greece’s reform challenge.

Export-led growth through a devalued drachma is anathema to Greece’s real reform challenge. It’s a shortcut to growth, and a fake one at that. It treats the symptoms – higher inflation and higher labor costs leading to lost competitiveness – rather than the illness, which is a structural gap between spending and revenues coupled with an environment that destroys free enterprise, innovation and risk-taking. A devalued drachma could possibly help with the recovery – but if it undermines the reform agenda, if it makes Greece cheaper but not better, then it is a bad idea. And Greece has had enough of bad ideas.

A Positive Sign in Greek Inflation

The Greek Statistical Agency released its inflation estimates for November 2010 and there is finally a noticeable downward trend in annualized inflation, which is a central element in Greece correcting its years of over-inflation and regaining relative competitiveness (see previous posts here). From a peak rate of 5.7% in September 2010, inflation has come down to 4.8% in November. This drop is in itself good news; but it is better news when coupled with a small but continuing rise in Euro area inflation which is estimated to have hit 1.9% in November 2010. This is the same rate as in October 2010 but both months mark the highest inflation rates since the crisis began, when inflation was 2.1% in November 2008. Clearly the price adjustment that Greece needs to make is still considerable, but this is a good data point in that direction.

Tuesday, December 07, 2010

Greece’s Brain Drain: Studying Abroad

Long-term reform requires that the government tackle the mess that is Greece’s educational system. This is a vast subject with many facets; I want to limit myself here to the brain drain that the country experiences when Greeks study (and often stay) abroad – a subject that is close to my heart since I too contribute to the brain drain. Still, I want to limit this post to some numbers on the subject.

In 2008, there were 34,200 Greek students studying abroad according to the OECD, of which 37% in the United Kingdom, 16% in Germany, 13% in Italy, and 6% each in the United States and France. On a per capita basis, Greece ranks 63 out of 207 countries in terms of students abroad. Yet given that most countries on the list are small or micro-states, Greece’s relative position is in fact higher: looking at countries with at least 5 million people (an arbitrary cutoff), Greece jumps to fifth place (out of 113) after Slovakia, Hong Kong, Bulgaria and Zimbabwe.

So far, no surprises. What is remarkable, however, is that the number of Greeks studying abroad has halved since 2000. In 2000, there were 63,500 students abroad, amounting to 13% of the Greek student population of 422,000. By 2008, just over 5% of Greek university students were abroad.

What happened? Quality improvements in tertiary education are probably not the answer; I say this purely based on anecdotes and stories about the state of Greek universities. Instead, what happened is that the enrollment in Greek universities grew by 50% since 2000. Fewer students go abroad because more can go to Greece. Likely, this is keeping at home students who would otherwise give up and leave the country, but it is unlikely to have dissuaded those who reject the system wholesale as one that does not offer enough opportunities to begin with.

How this plays out will be central to Greece’s future trajectory. There is a story about Ireland that is quite relevant here. In 1990 Intel said it would set up operations in the country. This was a success for the Industrial Development Authority (IDA) whose goal was to promote investment in Ireland. To convince Intel, IDA had to reassure it that the country had qualified people; “The IDA came up with a plan to address Intel’s concern: [IDA CEO Kieran] McGowan compiled a list of Irish engineers working at semiconductor businesses, mainly in the United States, who would be willing to return to Ireland. As McGowan put it, ‘We presented a booklet to Intel with the names, addresses and phone numbers of 85 people. And I think that impressed them’” (here).

I think the next three years will be a key period in determining how long that booklet will be for Greeks living abroad.

Saturday, December 04, 2010

Dissecting Greece’s Growth Record

To believe that Greece can avoid default is to believe that it can create sustainable long-term economic growth. Without it, no reforms, no bailouts, nothing will save it. So where might Greece find growth?

First ask, where has Greece’s growth come from? Between 2001 and 2008, 78% of Greece’s growth came from private consumption; government spending and investment each contributed 17%. Because Greece ran persistent trade deficits, trade subtracted 12% (exports are a minus in the GDP equation). This distribution is atypical: in the EU-15, in the same period, only 53% of growth came from consumption, 25% from government spending and 20% from investment. Trade also made a 2% contribution in Europe.

The excessive reliance on consumption for growth reflects, in part, the undue dependence of the Greek economy on consumption, which made up 74.8% of 2009 GDP versus 58.4% in the EU-15. Greece is in fact the country with the greatest reliance on consumption for GDP, several percentage points ahead of second Portugal at 67%. In part, this disparity emerges because Greece is running larger deficits than its peers. But it is also due to less government spending and less investment by companies.

What about specific industries and their importance for GDP? The nomenclature breaks GDP into 6, 31 or 60 subsectors. Let’s focus on the six.

Agriculture; fishing. In 2000, agriculture and fishing made up 6.5% of gross value added (gross value added plus taxes equal GDP). Between then and 2009, however, the contribution from this sector declined in both absolute and relative terms to 3.2% of GVA. Even at that reduced rate, however, this sector had a disproportionate importance relative to the European average (EU-15) of 1.5%. In Greece’s case, there is an added issue: the sector employs 11.5% of the people, the highest in the EU-15 and three times the average of 3.4%. The mismatch between employment and GVA is striking and underlines the importance of absorbing the rural labor force into more productive uses.

Industry (except construction). In 2000, industry made up 14% of GVA, and in 2009, it did 13.3% - so industry has grown in tandem with the rest of the economy. The share of industry, however, is below the European average (17.4%), although the share of industry in Europe has been falling declined – it used to be 22.2% in 2000. This reflects a process of deindustrialization and/or more focus on services. From an employment perspective, only 11.5% of the people work in this sector, making Greece the country with the fourth lowest share of industrial employment. However, there is overlap between industrial output and industrial employment.

Construction. Construction’s share in the economy was relatively stable throughout the 2000s, although the sector experienced a 27% drop in 2008 and 2009. By 2009, it made up just 4.6% of GVA. This share is below a European average of 6.2% and it is also below the share of Greek employment in construction at 7.7%. However, a rebound from the 2008-2009 collapse would easily bring construction’s share of GVA in line with European norms and with employment.

Wholesale and retail trade; hotels and restaurants; transport. This is by far the most important sector for Greece, making up 30.1% of GVA in 2000 and 33% in 2009. Almost 40% of Greece’s growth from 2000 came from this sector, driven by three segments: water transport (shipping), post and telecommunications (mobile telephony) and hotels and restaurants. This sector employs 32.3% of the people, which is broadly in line with its output share. These numbers make Greece more heavily reliant on this sector than any other European country and by a wide margin (EU-15 average for GVA is just 20.6%). However, this is also a sector that is highly cyclical; it was the sector that fell the most in 2009 after construction (in absolute terms the decline was the greatest of all sectors).

Financial intermediation; real estate. The share of this sector has been broadly flat, accounting for 20.6% of GVA in 2000 and 20.1% in 2009. The sector also employs just 10.1% of the people, so it is punching above its weight. In Europe as a whole (EU-15) the contribution of this sector to GVA is 29.8%, up from 26.3% in 2000. For a sector that in Europe employs just 17% of the people, this is certainly a very important contribution to the economy. It is also relatively stable, having shown the smallest declines in 2009 (second only to government spending, which rose in Europe in 2009). While the Greek sector is performing similarly well to Europe (in terms of GVA relative to employment), there is probably scope for more contribution to GVA.

Public administration and community services; activities of households. From 21.7% of GVA in 2000, this sector made up 25.7% of GVA in 2009. This includes both public salaries as well as items such as education, recreation, etc. In terms of employment, this sector made up 26.8% of the total, broadly in line with the GVA contribution. The GVA share is slightly above the EU-15 average of 24.5% and the employment is just below the EU-15 average of 31.7%.

What conclusions can one draw from this analysis? Our first set of data points shows that Greece (a) needs to correct its current account deficit which is wildly off European norms; and (b) that it needs to rely more on investment and government spending (public investment, not public sector salaries and social transfers) rather than private consumption.

Our second set of data points shows that (a) agricultural employment remains a big drag; (b) industrial production is much below European norms, as is financial intermediation / real estate; and that (c) the greater-than-average dependence on wholesale trade exposes Greece to over-cyclicality. Not that Greece should always seek to reach European levels because they are “right” but they certainly suggest some directionally important dynamics.

Monday, November 29, 2010

The Euro After Greece and Ireland

As the Eurozone unveils both a rescue package for Ireland as well as a blueprint for dealing with sovereign debt crises post 2013, it is a good time to muse on the future of the euro as a currency.

To begin with, there were at least two design flaws in the euro, one economic, the other political (both were well known at the time). From an economic point of view, a common monetary policy works only under synchronized business cycles and similar inflation rates. The business cycles, however, were never too aligned in the Eurozone: from 2001 to 2007, the fastest growing country was booming at 5.8% a year, while the slowest was almost in recession, growing barely at 0.3%. Some countries needed tight monetary policy, while others would have benefited from monetary expansion.

Inflation too was varied. At any given year, the country with the highest inflation in the Eurozone had an inflation rate that was 3-4 times higher than the country with the lowest inflation. A basket of goods would have appreciated by 7% between 2000 and 2007 in Finland, while it would have appreciated by 22% in Greece. Average inflation was stable, but there was great variation among members, making a common monetary and exchange-rate policy too impractical for all.

The second flaw was political. While monetary policy was too rigidly similar, fiscal policy was too loosely dissimilar. The Eurozone included only high level fiscal boundaries – deficits should not exceed 3% of GDP and debt levels should be under 60% of GDP. But when countries started to exceed these limits in 2005, the Council of Ministers did nothing to punish them.

At issue was an ambiguity about what precisely a common currency meant. In theory, countries retained fiscal authority and had the freedom to run their own accounts. In theory also, the debts of a country were strictly its own. In practice, however, there was a great convergence in bond yields: the standard deviation in bond yields among the Eurozone members was 70 basis points in 2001. In 2007, it was 13 basis points. So by 2007, markets saw no difference in the riskiness of the debt of the Eurozone members. Greece was Germany and Ireland was France.

The problem was that there was no way to know what would happen if a country got in trouble. There was also no mechanism for the Eurozone to prevent a country from getting into trouble in the first place. Here, then, was a contradiction: the markets were treating debt created in the Eurozone as equal but the prudent members had no way to restrain the profligate ones.

The events of the past few years allow us to revisit those initial dilemmas. The synchronicity issue has proven to be extremely important. Higher than average inflation rates in Greece and Ireland, for example, fueled borrowing and undermined competitiveness. Rigid exchange rates will also hinder recovery as these countries cannot depreciate their currencies to make exports instantly more attractive. Instead, they will need to experience either outright deflation (Ireland) or slower than average inflation (Greece). For these macroeconomic challenges, nothing that has happened in the past twelve months has provided any solution.

On debt, the message so far is mixed. On one hand, the markets were foolish to treat Greek debt the same was as German debt. On the other, they were not. Germany did, in fact, step in to help. Greek debts did become European debts – at least for now. Spreads shot through the roof, indeed, but at the end, spreads measure not the riskiness of individual country bonds; rather, they measure the political appetite in Germany to keep bailing out the more spendthrift members of the union. And the volatile in that appetite is as high as the volatility in the spreads.

None of this is a surprise, and the founders of the euro were well aware of its limitations, though perhaps they may have under-appreciated the magnitude of the crisis in which some countries have found themselves. For some smaller countries, the membership in the euro has brought clear benefits, even though it has also entailed some real costs. A Greek poll in November showed that 60% of the people thought the country should default or restructure, but a full 69% thought that it should stay in the euro. No drachma longing here.

The question is more for Germany – does it benefit from the euro? Many people say that instead of Greece and Ireland leaving the euro, maybe Germany should. But the question is this, does it matter? Instead of asking, do the new provisions provide enough guarantees to Germany that it can restrain profligate spending, the question to ask is, does Germany’s commitment to bailing out a fellow European depend on euro membership?

If one looks at the rescue packages for the non-euro members of the European Union (Hungary, Latvia and Romania) all involved a combination of both IMF and EU money. Euro or no euro, bailing out fellow Europeans might happen either way. And euro or no euro, Germany and others need more measures to monitor behavior and punish excesses.

How can this monitoring coexist with basic principles of democratic government? As a matter of principle, it cannot. A Greek who votes for parliament and prime minister needs to know that these bodies will have power to wield – decisions on how much to spend and tax should come from politicians at home, not politicians and technocrats abroad. But this just in principle. In practice, this is precisely what happened to Greece: bureaucrats from the IMF, the ECB and the EC are telling Greece how to run its affairs.

I guess where all this brings us is this: the fundamental economic and political dilemmas that came with the birth of the euro have hardly been resolved. The market presumption that Greek debts are German debts was foolish – and then correct – until now at least. And the messy debates to avoid meddling in domestic fiscal affairs have become moot at the point when the sovereigns in crisis called for help. So much resolved and nothing resolved.

Sunday, November 28, 2010

Ireland versus Greece: A High-Level Comparison

Greece and Ireland in the same economic sentence - in normal times, this would be unthinkable, Europe’s economic darling and the black sheep. And yet Ireland is country number two in the Eurozone to seek an aid package. The story of the two countries could not be more different.

Unlike Greece, Ireland experienced both strong economic growth as well as improving public finances in the last twenty years. While Greece ran persistent budget deficits, Ireland made a concentrated effort to curb its debt. In 1987, public debt reached an all time high of 112% of GDP; by 2007, debt was just under 25%. During the boom years, from 1997 to 2007, the Irish government ran budget surpluses averaging 1.6% of GDP.

Also unlike Greece, Ireland experienced a sustained and material improvement in living standards. In the 1980s, the Irish had a per capita national income that was 60% of the European (EU 15) average. From 1990 to 2007, the Irish economy grew at an astonishing 6.4% a year - by 2007, Ireland had a per capita income that was 26% higher than the European average, trailing just Luxembourg, Denmark and Sweden.

So what went wrong in Ireland? Broadly speaking three things:

First, the economy was over-heating: the IMF believes that in 2007, Ireland grew at 7.1% above potential. Several distortions emerged as a result. Inflation was 70% above the Euro area average, producing negative interest rates from 2000 to 2007 and leading to a gradual erosion in competitiveness. Manufacturing wages grew much faster than in Ireland's trading partners: between 2000 and 2009, Ireland's manufacturing wages grew by 30% more relative to its trading partners. What is more, the Irish economy is deeply weeded to Europe and United States – a slowdown there had a disproportionate impact in Ireland.

Second, cheap credit produced a housing bubble. From 1975 to 1994, Ireland built ~23,500 homes a year; this number began to rise and in 2006, Ireland built more than 93,000 homes. While much of that growth replenished and upgraded the housing stock, it created at least three distortions. First, there was a rise in housing prices, which rose fourfold from 1995 to 2007. Second, construction made up 13% of national employment in 2007, up from 6-7% in the 1990s. And third, the banking sector became increasingly intertwined with real estate: in June 2010, more than 50% of credit outstanding was either to real estate and construction businesses or to residential mortgages.

The housing bubble was only the most extreme form of a rise in private debt. Irish households had a gross debt-to-income ratio of 108% in 2002; by 2009, this had grown to 200%. For non-financial companies, the debt-to-income ratio was just over 4; by 2009, it had grown to 10. To make this kind of lending possible, Irish banks relied increasingly on (short-term) loans. Irish banks had a gross external debt of $284 billion in Q1 2003, but that number grew to a high of $1 trillion in Q3 2009. At the end of Q2 2010, Irish banks had short-term liabilities of $610 billion, far above the $100 billion or so of government debt. As the Financial Times put it, “The trigger for Ireland’s bail-out was not the sovereign’s inability to borrow (it is funded well into 2011), it was the inability of Irish banks to refinance their borrowing in the wholesale markets.”

The third big problem was that fiscal policy was highly pro-cyclical. When the economy shrank, revenues plummeted while social spending took off. From relative balance in 2007, government spending rose by 12% between 2009 and 2007 while revenues collapsed by 20% in the same period. This demonstrated the country’s fiscal weaknesses: while Ireland had managed to run budget surpluses, the structure of revenues and expenditures changed in at least three ways.

First, there was a steady erosion in the tax base: in 2010, an estimated 45% of tax units were exempt from the income tax, up from 34% in 2004. According to the political economy narrative, this erosion was part of a grand bargain forged in the late 1980s and early 1990s whereby unions traded slower wage growth in return for lower taxes. Second, the tax system became increasingly dependent on "pro-cyclical" revenues such as corporate taxes, capital gains taxes and stamp duties. In 1987, according to the Honohan Report, these made up 8% of tax revenues; by 2006, they were 30% of the tax base. When the economy shank, therefore, tax revenues were hit hard. Third, the size of the public sector grew by 30% between 2008 and 2000 and public sector wages rose faster than private sector ones. Hence, there was more rigid expenditure in place when revenues dropped.

Putting all this together paints a very different picture. Where Greece faced chronic deficits and a high debt to start with, Ireland had been running surpluses and had paid down its debt. Both countries experienced higher inflation than the Euro average; this produced increased indebtedness in both countries, though the property bubble in Ireland was much more pronounced. While Greece’s main challenge is to infuse a stagnant economy with some dynamism and competition, Ireland just needs to regain some of its vibrancy. And lastly, while Greece’s challenge is mostly around government debt, Ireland’s challenge is to recapitalize its ailing banks.

IMF, Article IVs
Central Statistics Office 

Saturday, November 27, 2010

How Important is Shipping for Greek Trade?

Tourism and shipping are the two most important industries for Greece’s exports, and in 2009, ~57% of Greek exports came from either tourism or shipping. I have written about tourism in the past (see here); now, I wanted to take a quick look at shipping.

Shipping enters the current account both as a good and a service: the former refers to the buying and selling of ships, while the latter deals with maritime services provided by Greek companies. To understand Greek shipping means balancing out four separate pieces: (a) the money sent abroad to buy ships versus (b) the revenues generated from the selling of ships; and (c) the money earned by providing maritime services versus (d) the money spent to purchase maritime services (e.g. at ports, logistics, repairs, etc.).

If one looks at maritime service exports alone (c), there has in fact been a boom: at the peak in 2008, the Greek economy exported €17.6 billion worth of maritime services, a near doubling versus 2002 (€8 billion). But in net terms, the contribution to the current account grew from €4.4 billion in 2002 to €6.4 billion in 2008 – an important increase, but much less than would be expected from the gross growth in revenues.

The reason is twofold: first, Greek ship-owners have expanded their fleets, prompting a capital outflow to pay for these ships. In nominal terms, between 2002 and 2009, ship-owners spent almost €27 billion to buy ships – they also, however, earned around €10 billion by selling ships. So in the eight years from 2002 to 2009, Greece spent a net of €17 billion on ships – around 2.2 billion a year. Besides the increase in ship purchases, the Greek shipping industry also increased its purchases of maritime services from abroad (d): from €4 billion in 2002 to almost €6.5 billion in 2008 (at the peak). While the services account was still growing, the net increase was smaller than the gross one.

Putting all this together, therefore, shows a more nuanced role for Greek shipping in terms of the current account. The peak contribution came in 2004 and 2005 when charter rates were rising (see receipts) but before the Greek shipping industry started a massive fleet expansion program, which started in 2006 (where ship purchases doubled from €2.3 billion to €5 billion). Once the fleet expansion began, the contribution to the current account shrank. In fact, in 2007, at the height of the commodity boom, the contribution to the Greek current account was no greater than it was in 2002. After the drop in 2009, it was even lower.

Of course, there is more to life than the current account: the Greek-owned shipping fleet increased more than 50% since 2002 and shipping companies were able to continuously lower the age of the fleet as a result. But in terms of the Greek current account, the contribution of shipping has been steady and, after 2005, modest, at least insofar as its ability to constrain the country’s ballooning current account deficit.

Friday, November 26, 2010

Greece's Public Mood

A poll conducted early November and the latest short-term confidence indicators provide a glimpse into the national mood.
The consumer confidence survey registered its lowest point ever in October 2010 at -72 (the number is the difference between the responses which indicate positive answers versus negative ones: e.g. -100 means all responses were negative). This is by far the lowest point on record since the survey started in 1985, and it also marks a progressive deterioration in consumer confidence: in 2009, the average was -45.7, while in 2010, the average has been -61.7.
The individual indicators are bad as well. More than half of the respondents expect a serious deterioration in the economic position of their household in the coming 12 months, and almost two-thirds think that the country's condition will grow much worse in the same timeframe. More than two-thirds (69%) think it unlikely that they will save any money in the next 12 months; 85% think unemployment will worsen considerably; 91% think it unlikely to purchase a car and 93% think it unlikely to purchase or build a home.

Political polls show a similar pessimism. About two-thirds of the people are fed up: 66% of the people do not trust either the prime minister nor the finance minister to handle the economy. A similar share has no faith on the leader of the opposition either. No wonder the abstention rate reached almost two-thirds in the second round of local elections in November 2010 (combining pure abstention with those voters casting an invalid ballot).

What is also interesting is the view that people have about Greece's current position. About 60% of the public believes that the country should either renegotiate with its creditors in order to pay less (46%) or cease payments and default (14%). Only 23% believe that Greece should implement the reform program underway and pay back its debts.

When it comes to assigning blame, the following graph is telling: besides successive Greek governments, the public blames speculators and Greek banks most, while there is much blame thrown on Greece's EU partners and foreign banks. There is, however, a notable 44% that puts much blame on the Greek public - though at least in my experience this tends to mean "everyone else but me."
What do all these numbers tell us about Greece's condition? In general, there are three views on Greece: first is the view of the government which says "we are making unprecedented changes, give us time." Second is the view of international investors and pundits who tend to have a high level view of the "stylized facts" and who say "Greece is not meeting its targets." Third is the view of the Greek public. At best, the public can provide begrudging consent; at worst, it can oppose them. If we combine these numbers with the abstention rates, however, the message that comes across is this: "It's bad. We know it’s bad. And it will get worse. Not much we can do about it, but don't expect us to like it."

Thursday, November 18, 2010

Five Myths About the Greek Crisis

Greece is in a tough spot. No doubt about that. But not all the things said about Greece are true. Here are five myths about the Greek crisis.

Myth #1 is that the Greek taxpayer would be instantly better off if the country defaulted or restructured its debt. In fact, Greece is running a primary deficit in 2010 and 2011, so even if it spent no money on debt service, it would need to cut spending or raise taxes by more than it is currently doing in order to balance its budget. Only after 2012 does a default mean that the Greeks can spend more by not having to service debt (see here).

Myth #2 is that the Greek economy is derailing beyond expectation. In fact, the economy is shrinking at precisely the level that the Greek government and IMF forecasted it would when it lent money to Greece in May 2010. A 4% GDP reduction was expected for 2010 and the economy so far in 2010 has contracted by 3.7%. This is unpleasant, but it is not unforeseen (see here). And the program assumes it will get worse, forecasting a 2.6% GDP drop in 2011.

Myth #3 is that rising spreads on Greek bonds are a problem. The spreads on Greek bonds versus German bonds remain high and have risen lately. But these spreads have no immediate impact on finances (since Greece is not borrowing money at long maturities) and they are also the result of very low liquidity. So they do not say much about Greece at all (see here).

Myth #4 is that Greece is missing wildly its targets. In May 2010, the Greek government committed to reduce its budget deficit from €30.882 billion in 2009 to €18.691 in 2010, a 39.5% reduction. In the latest (October) budget execution bulletin, the government said that the deficit would reach €19.473 billion in 2010, which is a 36.9% reduction (see here). The revised deficit and debt numbers are going to make what is needed going forward greater, but this is a swing of more than €10 billion. This is huge progress and just below what was expected. Even the IMF noted that, “the program has made a strong start.”

Myth #5 is that because Greece ends the IMF program with a debt that is higher than it is today, this proves that Greek debt levels are unsustainable. Hardly. Greece ends up the program with a higher debt level than when it started – this is true and this is the nature of a country that is undergoing a fiscal consolidation that cannot happen overnight. Since the country needs to keep running deficits, its debt will rise.

But whether this means that Greece’s debt is unsustainable is another question. Whether Greece defaults is not a function of whether Greek debt will be 144% or 150% or 160% of GDP. Rather, whether Greece defaults will depend on (a) whether the reforms underway have taken root and (b) whether markets have an appetite for riskier bonds. In fact, if the latter is true, Greece could get off the hook even without the former.

Tuesday, November 16, 2010

How Dependent Are Greek Banks on ECB Funding?

In the past year or so, Greek banks are increasingly relying on funding from the European Central Bank (ECB) to shore up their balance sheets. Presumably, this is because Greek banks carry higher risks and they are thus “shut off” from the international banking system. But how important is ECB lending? And is that reliance on the ECB growing?

To begin with, the amount that Greek banks borrow from the ECB is not reported as such. Instead, when banks borrow from the ECB, they need to post collateral with the Bank of Greece; looking at that figure lets one gauge the amount that Greek banks have borrowed from the ECB.

The graph below plots that number since 2008. As is clear, there were two waves of borrowing – the first took place towards the end of 2008 as the economic crisis unfolded, while the second wave was from February to May 2010 as the Greek economy faced increasing scrutiny and pressure in international markets. Importantly, the absolute value of ECB borrowing peaked in July 2010, although the decline since then has been minimal.
 Looking at the sources of funding in more detail shows the following dynamics: since the end of 2008, the direct funding for Greek banks from non-Euro area Monetary Financial Institutions (MFIs) has declined by €15 billion (see here). Euro area MFIs have also reduced their lending Greece, although it was not until May 2010 that this happened. The ECB lending is a response to this reduced lending, but its magnitude is much greater than that, and the main driver for ECB borrowing is compensating for capital flight (see here).

 To put things differently, since December 2009, the balance sheet of Greek MFIs has increased by €62 billion. In part, this is a statistically overblown number because it includes some previously unrecorded securitized assets (€37 billion). The rest comes exclusively from the ECB which is enough to offset the decline in deposits and ensure that balance sheets keep rising. By September 2010, however, almost 18% of the assets/liabilities of Greek banks came from ECB – up from 10% in December and from 3% in September 2008.

Monday, November 15, 2010

Obsessed with the Spreads

The English word "spread" was almost non-existent in the Greek vocabulary nine months ago. By early 2010, however, the press and the public could talk about little else; what are the "spreads" doing today; how are the spreads reacting to the latest numbers; the spreads fell 50 basis points? Fantastic. They rose 20 basis points? Oh no - catastrophe. If there is one number that can capture the national mood, it is the "spread." But what exactly do spreads tell us about the Greek economy and its ability to avoid default?

By way of background, when people talk about spreads, they mean the difference in the yield on the 10-year government bond for Greece and the yield for the same bond for Germany. Simply put, the yield is the expected return for an investor holding a bond, and it is a function, among other things, of a bond's face value and its current price. If the bond's price falls, the yield rises. When yields rise, investors want a higher return to hold an asset. The graph below shows the yield on 10-year government bonds and, in effect, shows what interest rates investors require to hold Greek government bonds.

 The spread is the gap between this yield curve and the yield curve of the German government bonds. Given that German bonds are equivalent to a "risk-free" asset (and thus do not move much), the yield on Greek bonds and the "spread" follow similar paths (as you can see here).

Spreads were flat for a long period of time, but towards the end of 2009, they rose a bit and peaked in December 2009. Then, they fell again, reaching a low in May 2009. They started rising again in late 2009 and experienced a steady increase with the exception of two lulls: May 2010, after the Greek government announced it had reached a loan agreement with Europe and the IMF; and in September 2010 after the first positive review of Greece's progress by the IMF. Recently, however, the spreads have risen again, partly due to fears that a revision in Greece's deficit and debt figures will force the government to take further measures that will only deepen the country's recession.

But what precisely do rising spreads mean? They mean that investors demand a higher price for holding Greek government debt. But there are several caveats in turns of what this statement really means.

Greece is not really raising long-term funds in international markets: its funding needs are being met by the IMF and the European Union. Greece is indeed active in international markets, but its sole transactions since June 2010 have been in the short-term market with T-bills that have a duration of 13 or 26 weeks. The yields for these transactions are much lower since the fear of default is lower. Since Greece is not raising new funds, rising yields do not impact borrowing costs: what Greece owes investors is determined by bonds it has already issued.

Even so, don't the yields indicate the risk that investors attach to Greek bonds? In theory, yes. But since May 2010, the secondary market for Greek bonds has essentially disappeared. On average, in 2009, the trading volume for Greek bonds in the secondary market was €27.2 billion a month. In the first quarter of 2010, that volume had dropped to an average €23.4 billion a month. After May 2010, however, the trading volume collapsed to €1.4 billion a month. In other words, higher yields demonstrate higher perceived risk, but among a smaller group of active trades. They are therefore less meaningful as a price signal on what Greece would be able to theoretically borrow for if it went to the market.
There is one area where higher spreads matter: as collateral. When banks conduct transactions, they have to post collateral, and what others accept as collateral varies. If Greek government bonds are less desirable, they are less useful as collateral, and that can hamper transactions. At the same time, Greek banks have relied more on the European Central Bank, rather than commercial banks, for funding. For the ECB, the main parameters for valuing collateral are credit rating, maturity and liquidity - so higher yields may be less important.

Does that mean that spreads do not matter? Of course not. They are useful indicators of market sentiment, although they are not as telling as some analysts or the press seem to suggest. They tell a story in other words, but not the whole story by any means.

Sunday, November 14, 2010

Greek Budget Review: October 2010

The October Budget Execution Bulletin (in Greek, here) shows little change from the figures presented in September 2010. Revenues for the year until October were up 3.7% versus 3.6% in September – a modest improvement but still shy of the 8.7% target in place since September 2010. Expenditures remained 7% down versus last year, but are still short of a (revised) target of 7.8%.

Overall, the deficit is down 29.9%, which is one percentage point below the September 2010 figure (30.9%), and a full seven percentage points below the target of 36.9%. What is more, the budget balance reduction is the smallest that has been accomplished so far in the year, pointing to further difficulties in reaching the targets.

In other words, the story that has been shaping in the past few months remains: revenues are under-performing, with the state being unable to raise as much as it needs (see here for more details); expenditures are falling as much as forecasted, and often more – leading to higher targets; and the budget deficit is declining by slightly less than is forecasted, and the reduction in the deficit is getting smaller as time goes on.

Greek Economy Shrinking Exactly as Expected

The Greek statistical authorities just published their estimates for GDP in the third quarter of 2010: in real terms, the economy declined by 4.5% relative to Q3 2009 and by 1.1% versus Q2 2010. The authorities note that “the GDP rate of change between the quarters of 2009 and 2010 should be treated with caution, due to the discontinuity of General Government data series.” Still, this is not good news. However, the economy is shrinking at exactly the rate that it is supposed to be shrinking.

The Greek economy has been shrinking since Q4 2008. What is more, the rate of decline has consistently accelerated with only one data point – Q1 2010 – showing less decline than the previous quarter. In 2009, the economy shrank by 2.3% with the end of the year being worse than the beginning, and in 2010 so far it has shrunk by 3.7%.

It is important to understand, however, that this decline is exactly what the troika forecast when it agreed to lend money to Greece in May 2010. In fact, the real GDP growth forecast has not yet changed between what the authorities forecasted in May 2010 and what the government announced in its 2011 budget program in October 2010. Some data revisions may change that in the future, but the point is that the economic is shrinking exactly as planned.

Looking at that forecast shows that the 3.7% GDP decline so far in 2010 is very close to the 4% decline that the program assumes. Nor is the program sanguine about things getting better. In 2011, the economy is supposed to shrink further by 2.6%. It is not until 2012 that GDP growth will resume and even then the growth is assumed to be anemic at 1.1%. By 2013, the program expects the Greek economy to start increasing at healthier rates, above 2%.

This, then, is the most depressing and difficult part about the government’s handling of the program. The economy is performing more or less as expected and the squeeze felt by households and business is in line what was supposed to happen, which means one can hardly blame the government for things “going wrong.” And in fact, we still have at least another year of worsening conditions before things get better if all goes according to plan.

Friday, October 29, 2010

How Much Does Greece Matter?

The Bank for International Settlements (BIS) just published its international banking statistics for Q2 2010, showing, among other things, the exposure that one country’s banks have on other countries. In June 2010, the 24 countries that report data had an ultimate exposure of $156 bn on the Greek economy – the majority of that exposure was to the non-bank private sector (50%), followed by the public sector (41%) and then banks.

Over the past nine months, foreign banks have gradually unwound their positions on Greece. From a high of $297 bn in Q3 2009, foreign banks have reduced their exposure to Greece by some 50% or $141 bn. More than half of that decline came from Switzerland, which lowered its claims $78 bn to $3 bn between Q3 and Q4 2009. This reduction was part of a broader strategy by Swiss banks to shore up their balance sheets: between Q1 2008 and Q2 2010, Swiss banks lowered their foreign claims by 40% or $1 trillion.

Besides Switzerland, the two countries most exposed to Greece are Germany and France, which together hold around 60% of the global claims on the Greek economy. Both countries, however, have reduced their exposure to Greece since Q3 2009: the French by $21.2 bn and the Germans by $6.4 bn. Still, these two countries stand to lose the most in the event of a Greek default.

But how much do they stand to lose? The nominal amount they held in June 2010 – $94 bn – is significant. Yet that number is marginal in the overall portfolio of these countries’ banks. For France, claims on Greece represent some 1.8% of total global claims; for Germany, the number is 1.2%. Only for Portugal, which is the fourth largest holder of Greek liabilities, does a Greek default pose a serious problem since 7.2% of the total claims of Portuguese banks were on Greece.

None of this is to suggest that default would not hurt these banks or these countries’ banking sectors. Given that capital adequacy requirements can easily swing if a few billion dollars worth of assets are impaired, an exposure of $156 bn is quite serious. Yet, it is quite clear that French and German banks are both reducing their exposure to Greece (the French a lot more so) and that as a result, the impact of a possible Greek default on their balance sheets becomes progressively smaller.