Wednesday, April 27, 2011

Eurostat Revises Greece’s 2010 Deficit: Why it Matters

Eurostat has put Greece’s 2010 budget deficit at 10.5% of GDP, up from a previously estimated 9.6%. This revision matters not because it pushes Greece closer to default, but because it changes how a default would play out. 
Think about default in two dimensions. First, can the country borrow at reasonable rates? If it cannot, it will default. And second, in the absence of having to service an insurmountable debt, how do finances improve? The relevant numbers for Greece are shown in this table. In 2011, the country’s gross borrowing need of €58.7 billion is covered without a need to issue long-term debt (short-term debt is cheaper since it carries less risk). By 2012, however, the country was forecasted to need to raise €26.7 billion from the long-term market. If Greece cannot raise this money at a reasonable rate, it would be forced either into default or another bailout.

The other relevant number is the primary deficit, which is the deficit without interest payments. What is important here is that Greece ran a primary deficit in 2010 and was forecast to run one in 2011 as well. It was only in 2012 that the country was expected to run a surplus. In other words, even if the country spent no money to pay interest, its budget would still be in the red – thus, a default would not provide an immediate stimulus since the government would need to pair a default with raising taxes and/or cutting spending further.

By 2012, however, the country was expected to run a primary surplus of 1% of GDP. At that time, if the country found it impossible to raise money from long-term markets, the government would be forced to default or ask for another bailout, but at least the act of default could offer some instant reprieve to the economy (alongside the obvious negative consequences of course). By not having to service debt, the government could either lower taxes or boost spending to the tune of 1%.

The revision in the 2010 deficit, however, wipes out that primary surplus in 2012. In the event of an outright default, therefore, the government would need to complement a suspension of payments with more fiscal measures. This is the short-term equivalent of having all the negatives of default, but none of the positives. So the true significance of the new deficit number is not that it makes the debt math less favorable, but that it makes even the math of default more difficult.

Monday, April 25, 2011

The Debate that Greece Still Needs to Have

I have written in the past about the need for a more honest accounting of how Greece got into this mess (here) as well as for more clarity from the government about what needs to happen next and where the country should be headed (here). It is no surprise, therefore, that I found the following diagnosis, by Bank of Greece Governor George Provopoulos, to be heartening: 
 
"There has been no full explanation of the causes of the crisis and of the effort required. The policy inaugurated in May 2010 challenged certainties that for many years were unassailable and it clashed with the dominant attitudes of the past. But there have been no convincing answers to the questions: how did we get here? Why did the development model that we followed the last thirty years collapse and what does a “new development model” mean? What are the real facts today? What rights, obligations, opportunities, responsibilities and limitations does our participation in the EU and the Eurozone entail? What are the alternative options and what are their costs? Which dangers lurk and how to tackle them? What is the final result of this effort and how are the reforms promoted today linked to that?" (2010 Annual Report, p. 23; so far only in Greek here. My translation).

I do indeed hope to hear more of these discussions in the months to come.

Sunday, April 24, 2011

Are We All Greeks Now? Greek Political Economy and the Origins of Greek Debt

Greece used to be a beacon for the Western World. Now, it has turned into a lighthouse, warning debt-ridden countries on what path to avoid. Near the one-year anniversary of Greece’s bail-out, what can the world learn from Greece?

To learn the right lessons we first need a diagnosis – what happened to Greece? The bail out that the country negotiated in May 2010 was triggered by rising borrowing costs for a large and constantly revised budget deficit, which came on top of a large and also constantly revised public debt. But this tough position was only partly the result of the global financial crisis. In was rather the culmination of over 30 years worth of failed policies. This is a political crisis with economic dimensions.

To think about what happened to Greece, I want to turn to two concepts: Greece as a rentier state and Greece as a country facing soft budget constraints. Neither is a perfect analogy, but together they tell a compelling story.

A rentier state is the political science term for a state where “money grows on trees.” The money comes from either natural resources (think oil and Saudi Arabia) or from extorting a foreign state that for reasons of security or self-interest subsidizes the target country (think North Korea and China). Rentier states are distinguished by two features: they excel at spending money rather than raising it; and they tend to lack a social pact between governing and governed. Without a need to tax, the motto “no taxation without representation” does not work.

Running a rentier state is a great gig if you can get it (living in one is another matter). But few countries are as richly endowed or have the capacity to coerce a patron into giving them large sums of money for large amounts of time. What really prevents countries from being rentier states is that they face budget constraints: if they keep spending beyond their means, the money will run out.

Budget constraints, however, can be soft. It is clear that at some point, countries can no longer borrow from either their citizens or from abroad. At that moment, they are faced with a need to default on their obligations. But figuring out that point is far from easy. If Greece had been treated like Argentina, it should have defaulted in the mid 1980s – that it was able to sustain a higher debt level for so long means that the trigger from soft to hard budget constraint was much higher than for Argentina.

With these two concepts in mind, let us review the record on Greece. The preponderance of Greek debt was accumulated in the 1980s and early 1990s: In 1980, Greece had a debt-over-GDP ratio of 22%, which in 1988 rose to 61% and then in 1993 reached 98% of GDP.


What happened in the 1980s was state spending ballooned without a corresponding increase in state revenues. In part aided by two electoral cycles (1981 and 1985), the share of state spending went from 24% of GDP in 1980 to 43% in 1988, a 19-point rise. Revenues, by contrast, rose less than 7-points from 20.4% to 27%. Looking more specifically at the spending composition, transfers such as subsidies, grants and social assistance rose from an average 25% of the budget in 1980-1982 to 32% in 1986-1988 (reaching 37% in 1998). In other words, the state in the 1980s was increasingly spending money it was unwilling to raise in order to boost its legitimacy and popularity. As George Pappas put it, “PASOK’s basic contribution to Greek politics was to take the old clientelistic structure of control and reward and ‘massify’ it.”


Inevitably, Greece faced an economic crisis with debt and borrowing costs spiraling out of control. Output was flat in 1990, it rose in 1991 and 1992, but the economy was again in recession in 1993. As borrowing costs spiked, Greece was borrowing more to both finance its deficit, which averaged 12% from 1988 to 1993, and to pay interest on rolling over debt. In 1990, for example, Greece was dedicating over 15% to interest payments and debt amortization.

Starting in 1993, the government started a process of fiscal consolidation that culminated in the entry in the Eurozone in 2001. These years, which were known in Greece as austerity years (λιτότητα), led to a progressive shrinkage of the deficit to (a later revised) -3.1% of GDP. The data series is incomplete, but looking at the numbers since 1995, the consolidation effort was mostly a revenue effort with revenues going from 36.7% of GDP to 43% in 2000 (see also here). Spending, by contrast, remained broadly flat from 45.7% in 1995 to 45.3% in 2000. In this period, Greece achieved normalcy: budget deficits shrank and borrowing costs fell. Yields on Greek government bonds fell from 24% in 1992 to just 6% in 2000 – the spread with the Bunds collapsed from 16 percentage points to under 1.

From 2001, the fiscal discipline that allowed Greece to enter the Eurozone began to weaken. The weakening was mostly a relaxation of revenues, which fell to a low of 38% of GDP in 2004, while spending remained flat (as a share of GDP). But with Greece in the Eurozone, yields did not respond to rising deficits, which rose to 7.4% of GDP in 2004 (aided by spending for the Olympic Games). In fact, yields continued to fall, although in fairness to the yields, the Greek government did a good job to distort official statistics and make things look better than they were (see here). And since the European Council refused to punish any member state that exceeded the 3% deficit over GDP limit that Eurozone countries were supposed to abide by, Greece’s deficits were getting a free pass. Or at least they were until Lehman brothers.

*

To bring us back to our initial analogies: Greece in the 1980s became a quasi-rentier state with an increasing focus on spending resources rather than raising them. Predictably this triggered a recession and progressively higher borrowing costs, which forced the country to tighten its budget deficits. Greece did not seek to lessen the burden of the state in the economy; instead, it merely sought to finance it better by boosting revenues. But once it joined the Eurozone, its hard budget constraint softened – in fact, Greece hardly faced any constraint at all since yields showed no reaction to constantly escalating deficits. When it did, it was forced to look for official help.

Stepping back a little, we can see more clearly the challenge: think of rentierism as the internal challenge and the soft budget constraint as the external challenge. The external challenge is well understood: how to convince markets to lend money to Greece at reasonable rates. Whether they will do depends in part on their own moods, but it also depends on how they read Greece’s progress towards reform.

The internal challenge is thus to create a state that transcends its role as a vehicle for patronage either directly (jobs, subsidies) or indirectly (lax tax enforcement, competitive barriers). This is a deep structural challenge that may have been amplified in the 1980s but was certainly not born then. Emmanouil Roidis, a Greek satirist, wrote in 1875: “Elsewhere parties come into existence because people disagree with each other, each wanting different things. In Greece, the exact opposite occurs: what causes parties to come into existence and compete with each other is the admirable accord with which they all want the same thing: to be fed at the public expense” (Quoted in Richard Clogg’s book “Parties and Elections in Greece.”).

These deficiencies are significant for at two reasons. First and most obvious is that the country lacks the capacity to legislate and enforce the numerous reforms it has pledged to undertake. Second and more serious is that Greece needs to create political legitimacy that is not based on state spending. Such effort must be tied to a broader agenda and message – “we will not default” is a poor slogan and it contains no vision.

*

So what are the lessons for countries that are looking at Greece as the first domino to fall while they sit too in the domino line?

Lesson one is that “you cannot spend beyond your means forever.” Before you ask for your money back (this is a lesson??), remember that Dick Cheney was proclaiming only a few years ago that “deficits don’t matter.” It is true that deficits can be sustainable for a long time. But eventually they will get you. If I can modify the former Vice President’s words: “Deficits don’t matter. Until they do.”

Lesson two is linked to one: soft budget constraints allow countries to get away with bad policy for a long time. Twice Greece was forced to make changes after an economic crisis: in the late 1980s and early 1990s and then against in 2010. Yet Greece’s changes in the 1990s did not last. When the political goal was met – enter the Eurozone – the consensus disappeared and in the absence of any constraints, the state reverted to its old ways.

Lesson three is that debt is a political problem, not just an economic one, and it usually reflects an underlying political economy. In Greece it was the political economy of patronage, barriers to competition and lax enforcement of taxation. It was the political economy of legitimacy through state spending and letting future generations foot the bill. That structure did more than wreck the economy: it weakened the state’s capacity to govern by making it a mechanism for spending money and it also concentrated its basis of legitimacy on one pillar – spending. This, in the end, is Greece’s challenge: to create a state where political allegiance is divorced from patronage.

Who Holds Greek Debt?

As talk grows of Greece restructuring its debt, it is important to take a look at who really holds Greek debt and who will be affected by a potential restructuring. At the end of 2010, the Ministry of Finance (MOF) reported that the Greek government had an outstanding public debt of €340 billion, of which €286 billion was in the form of bonds and short-term notes and €54 billion in the form of loans (see here). Dissecting who holds that debt, however, is a murky exercise. Below is my effort to reconcile the numbers – these are estimates at best and I hope to revisit these numbers as better information becomes available (the graph shows Q3 2010 because that is the last date for which all data is reported).

 
 Domestic vs. Foreign

The main source for separating domestic versus foreign debt is the Bank of Greece (BoG). The BoG reports the country’s International Investment Position (IIP), which is effectively the country’s assets versus its liabilities (here). At the end of 2010, the BoG reported external liabilities for the General Government of €149 billion (lines 2.2.2.1 + 2.2.2.2). There is also the debt to the Troika under the bail-out plan, which at the end of 2010 was valued at €40 billion (line 4.2.2.3 in the IIP, which also covers some other small liabilities).

There is another tranche, which is less clear cut: bank borrowing from the European Central Bank (ECB). Greek banks borrow from the BoG by posting collateral, including Greek government securities or loans; in turn, the BoG borrows from the ECB. Since these assets remain on Greek banks’ balance sheet, we can classify them as domestic liabilities. Therefore, foreign ownership of Greek debt equals €149 billion + €40 billion = €189 billion, or 56% of total government debt.

Foreign: Details

The Bank for International Settlements (BIS) publishes data on bank holdings of Greek public sector assets. So far, the BIS has only published data to Q3 2010, at which time foreign banks reported an ultimate exposure of $71 billion to public sector assets in Greece – or €53 billion (16% of total Greek public debt). The rest of Greek debt held abroad, therefore, belonged to non banks.

Looking at bank claims on the Greek economy, however, it is important to recognize that exposure to the public sector made up just 42% of the total. Exposure to banks was just 8%, while the rest was to the non-bank private sector (50%). Foreign banks also have exposures, comprising of ~$110 billion in derivatives, guarantees extended and credit commitments. If we add these to foreign claims, Greek government debt made up 26% of the total. Foreign banks, therefore, stand to lose more from the ripple effects of a default than from the mere write-down of Greek debt.

Domestic: Details

Domestic: The BoG publishes the Financial Soundness Indicators for Greek credit institutions, which measures, among others, the holdings of Greek securities and loans. At the end of 2010, these amounted to €63 billion, or 12.6% of total assets, which is important but not extreme, leaving €80 billion in the hands of non-credit domestic entities. Although exposure by credit institutions has remained fairly constant since July 2010, given the deteriorating position of Greek banks (see here), government assets form an increasing share of the overall portfolio: from 8.5% in January 2009 to 10% in January 2010 and 12.7% in January 2011. Any restructuring would have an increasingly significant impact on Greek banks.

 
Conclusions

So what does all this mean? At a high level, bank impairment is less of a risk than the overall balance sheet deterioration that would result from a default. In the foreign sector, claims on Greek government debt are important, but they are only a fourth of overall claims and other exposures on the Greek economy. Importantly, credit to the non-banking private sector is bigger than ownership of government securities.

In the domestic economy, government securities and loans form an ever increasing share of total assets for local banks, and they also form a main pillar of banks’ borrowing strategy. To put these numbers in context, the Greek banking sector has lost €26 billion in deposits since December 2009 – so a €63 billion write-down, even partial, would be big. Even so the non-banking sector would suffer even greater losses, further impairing the balance sheets of households, corporations and other institutions.

Thursday, April 21, 2011

Spending Trumps Revenues in Greece’s Master Plan

Critics of the Greek government point to lagging state revenues to argue that the government is missing its targets – this is the number that receives the most media scrutiny and attention. And for good reason: in June 2010, after negotiating a bail-out plan with the IMF and the Europeans, Greece targeted a 13.7% increase in revenues for 2010. It achieved a 5.5% rise instead. And in Q1 2011, revenues have fallen by 8% against a targeted annual increase of +8.5% (although the projection forecast this seasonality). The (in)ability to raise revenues is thus crucial to the country’s future macro-economic stability (see here and here).

The following graph tells a compelling story for how to think of revenues and spending. It plots the historical data for state spending and state revenues as a share of GDP (taken from Eurostat) and it also shows the forecasts by the Ministry of Finance for the period to 2015 (note: the Eurostat and the MOF data differ slightly). What does the data tell us?


First, Greece’s fiscal consolidation plan is basically a spending plan: although the government emphasizes both revenues and spending, reducing spending far outweighs raising revenues. Spending as a share of GDP peaked at over 53% in 2009 and it is set to fall to 44% in 2015 with a 6.1 percentage point adjustment from 2010 to 2015. Revenues, by contrast, were at ~38% in 2009 and they are expected to rise to 43% - although most of the jump comes in 2011, after the share of revenues over GDP remains flat.

Thinking more broadly about spending and revenues, we can make two observations. First, government spending has been fairly flat as a share of GDP since 1995, at least until 2008, when it got out of control. The government is right that its 2015 target is to bring spending in line with past norms – which will be difficult but not unthinkable.

Second, revenues have been much more volatile in the last fifteen years. In the mid 1990s, as Greece cut its budget deficits to enter the Eurozone, it was higher revenues rather than lower spending which accounted for most of the adjustment. Revenue growth was driven by increases in tax receipts from households (14% average growth from 1995 to 2000) and corporations (20%). Looking at the period from 2000 to 2004, however, revenues fell as a share of GDP. Household taxes continued to grow at 5% but taxes on companies stagnated (-0.2%). When revenues started to rebound after 2004, they failed to rebound sufficiently – which, combined with higher spending, led to ever increasing deficits.

In that sense, the Greek government is aiming to defend revenues from falling, which they did after the last peak in 2000, and to curb spending to an extent it has never been done before. The revenue target sees revenues at the highest point they have ever been (at 43% of GDP in 2000) while spending is also forecasted at a point it has been only one before (in 2005). Greece’s target budget deficit, at 1% of GDP, is a goal that no Greek government has accomplished in 30 years.

If we also look at the past fifteen years, we can make two additional observations. First, tax collection suffered after 2000 and so the government should focus on ensuring this does not happen again. Second, this forecast says that the role of the state in the economy will resume its historical position (except in a more balanced budget). For a transition, this is fine. But going back to the level of state spending we have had since 1995 is still too much state. Reform should push for even less state.

Wednesday, April 20, 2011

Greece's Crumbling Silent Majority

For the past year, PASOK's case to the Greek public has been that it is making the best out of a raw deal. This is the context in which to think of the two-third abstention rate in the November 2010 local elections: few people thought there was a good alternative to PASOK, so they did not against PASOK. But nor could they vote for PASOK either - life was miserable and PASOK was hardly blameless. The government's mandate was thus built on acquiescence, not active support. That acquiescence is crumbling.

The political environment has now entered a vicious cycle: public discontent is feeding dissent in the ruling party, which in turn raises doubts in the minds of the electorate about the government's ability and willingness to carry out reforms. The latest public opinion report released by Public Issue is instructive in this regard (see here):

- There is a growing sense that the country is headed in the wrong direction with 81% of those polled saying so, up from 69% in January.

- The prime minister's popularity has reached an all time low. Only 35% of respondents have a positive opinion of him. This number, which is unchanged from March 2011, is by far the lowest of his tenure.

- The popularity of the government has fallen too. PASOK was elected with 44% of the vote in October 2009, but Public Issue estimates PASOK's share of a forecasted vote at 34% in April 2011, also a low point.

- No party is popular. The main opposition party (ND) is in fact less popular than the PASOK government. Right-wing LAOS gets the highest marks at 31% of those polled saying they have a positive view of the party, while party leader George Karatzaferis is the most popular politician in the country. Meanwhile, the intention to abstain remains high (35.5%)

To make sense of these numbers, go back to that (partly unspoken) pact that the government made a year ago with the public. George Papaconstantinou, the finance minister, put it well at the time: Greeks, he said, would tolerate hardship as long as it were evenly distributed; if PASOK tried to insulate its own constituencies, support would crumble. Well, this is now happening.

In my own discussions, which are a partial and unscientific sample, the complain I hear most is that the "reforms" are not reforming. This is a new complaint, one that has surfaced only in the past two months. In 2010, the complaint was that the government was not moving fast enough or that implementation was slow and that the targets were being missed. Few questioned the government's sincerity to make changes - they just questioned the execution.

The PASOK government now faces a fundamental question: will all Greeks be forced to change or will some Greeks have to change more than others? In 2010, the government was saying all Greeks would change. In 2011, it has pulled back from that commitment. This may please some special interests but the silent majority is watching closely. And they are disappointed by what they see.

Monday, April 18, 2011

The Doublespeak of Greek Debt Restructuring

For the past ten days, two stories have dominated the news cycle. First are stories that claim the IMF and the Europeans are discussing with Greek officials the possibility of debt restructuring; and second are stories that state claim no such discussions are taking place. Obviously, all sides should be (and likely are) considering the pros and cons of restructuring. This is no surprise. But what does all this talk mean and why does it matter? Let me begin first with four observations.

First, markets already assume that Greece will default. A series of Bloomberg polls conducted in 2010 and 2011 show that around three-fourths of respondents assume a Greek default, while several renowned economists regularly repeat their view that Greece will be forced to default sooner or later. Yields on long-term bonds continue to remain high, while Bloomberg reports that credit default swaps suggest a two-thirds probability that Greece will default within five years.

Second, default is already on the minds of the Europeans. In March 2011, the European Council endorsed a preliminary agreement whereby a “haircut” is likely scenario for any country seeking EU help after 2013. As Sebastian Mallaby put it: “In a masterpiece of double-talk, Europe’s leaders are reassuring bond holders they will get all their money back – except that from 2013 onward, they might not.” So the idea that restructuring is jut surfacing on the agenda is silly.

Third, the Greek government is increasingly unpopular. The intention to vote for the ruling party has reached its lowest post since national elections in October 2009. The prime minister’s popularity also took a deep dive in March 2011, reaching all time lows as well. Given that the government’s mandate is premised on the idea that the “Memorandum” is the only way forward for the country, talk of default makes its political position effectively untenable.

Fourth, Greece has no reason to default yet. The country will still run a primary deficit in 2011, so a suspension of interest payments does little good right now. Moreover, Greece’s financing needs for 2011 are met fully by a combination of short-term debt issuance and the money borrowed from the troika. Greece will need to return to markets in 2012 to borrow an estimated €40 billion – until then, high borrowing costs are a theoretical but not real problem.

All these observations paint the following picture: restructuring is on everyone’s minds, but the Greek government is steadily losing its popularity and to give credence to talk of restructuring could halt its reform agenda and possibly trigger its downfall. Thankfully for the government, it does not need to ponder default yet. The government’s dilemma is this: how to reconcile the fact that it may have to default with the reality that its best hope to avoid default is to implement a program whose basis of popular support is its claim to help the country avoid default? Exactly.

The government faces the following outcomes. First, and least likely, is that market conditions improve so dramatically that investors ease the pressure on the European periphery. In this case, the risk premium on Greece falls not because Greece is reforming but because markets are more risk taking. This scenario would assume a complete reversal of both market sentiment as well as European policy, which has so far fed market anxiety by indecision and by suggesting that future haircuts are possible.

Second (and ideally for the government), the government hopes that when it returns to markets in 2012, its reforms will have started to deliver results, thereby gaining some market trust. In this scenario, the government’s ambitious privatization program can play a dual role: not only does it convey a commitment to change, but it also helps raise money that the government then does not need to borrow from the market. In other words, by selling off assets, the government can reduce its borrowing needs and raise money at a more reasonable cost.

Third, the government may indeed have to default. On one extreme (but a likely scenario), the announcement of default itself would trigger the government’s collapse. On the other extreme, the government would survive a default. For this to happen, the economy should be already on a growth pattern, which realistically means mid to late-2012. Default would have to be painted as the inevitable outcome that will help expedite the transition, coming at a time to ease pressure on households and companies and accelerate economic growth. Timing will be key.

There is therefore little reason for the government to spend time thinking about default now. It is effective political suicide and it distracts resources from making the changes that the country really needs. Even if default comes (which it might), the government’s only hope to survive is to announce it from a position of strength given some economic improvement. This is what makes 2011 so crucial – it is the government’s last buffer year. Defaulting now means the government has given up.

Wednesday, April 13, 2011

Greek Banks Still in Bad Shape

In 2010, the Greek banking sector was confronted with the following challenges (among others): (a) increased dependence on European Central Bank (ECB) funding; (b) a steady fall in deposits; (c) a steady increase in non-performing loans; (d) an inability to grow credit; (e) a deteriorating loan-to-deposit position. In this post, I want to review how Greek banks have fared on those five counts.

ECB Funding. Since Greek banks started to borrow heavily from the ECB in early 2010, the markets have looked at ECB borrowing as a proxy for the banks’ ability to tap capital markets. In theory, banks would turn to the ECB only when they could not secure other funding. In practice, there was a big jump in ECB funding until July 2010, but since then this window has been stable with minimal month-on-month variation. This is good news, but it only signals stabilization, not increased health.

Decrease in deposits. Deposits of corporations and households peaked in December 2009 at €238 billion and they have since declined to €202 billion in February 2011, a 15% drop. Somewhat auspiciously, the drop has slowed: more than 70% of the cumulative reduction since December 2009 had taken place by July 2010. Even so, Greek banks are still losing deposits of ~€1.4 billion a month. The IMF notes that, “The continued outflows are at this point not related to confidence effects, and are in line with what one would expect in a shrinking economy where savings are being used to smooth consumption.”

Non-Performing Loans (NPLs). The share of NPLs has doubled from 5% in 2008 to 10% in September 2010, and so far, the trend is uniformly in one direction (worse). The deterioration in the loan portfolio comes from across the board: housing NPLs have less than doubled from 5.3% to 9.7% in the same period; consumer loans have performed even worse with an increase in NPLs from 8.2% to 18.4%. Meanwhile, business NPLs have doubled from 4.3% to 8.5%.


At the same time, write-offs have not increased substantially. However, the source of write-offs has changed: while consumer loans used to account for 13% of write-offs in 2004-2005, they accounted for 68% in 2010. Corporate write-offs meanwhile have fallen. Given that NPLs have increased for both consumer and business loans, the lack of write-offs in business loans could signal a future increase in write-offs as NPLs are written off completely.

Inability to grow credit. From double digit growth in 2006-2008, private sector credit grew 4.1% in 2009 and was flat in 2010. Whatever credit is extended is limited to the public sector, where credit grew by 28.6% in 2010, driven by purchases of government securities. Looking more closely at private sector credit, there has been an effective plateau to corporate credit since late 2008, while credit to individuals grew marginally in 2009. Starting in mid-2010, credit to both business and individual has fallen steadily.

Deteriorating loan-to-deposit (LTD) position. Stagnant credit growth and deposit reductions have led to a weaker LTD position. The Bank of Greece publishes complete data irregularly but the latest data point, for September 2010, shows the banks’ LTD ratio to have reached 114.4% from 106.6% in December 2009.

Looking back at the past few months, we can conclude: (a) ECB lending has stabilized but has not fallen yet; (b) deposits continue to drop, but 2H 2010 saw a smaller decrease than 1H 2010; (c) NPLs have effectively doubled from December 2009 to September 2010, while limited write-offs in business loans suggest more defaults are likely; (d) from flat credit in 2010, the more recent months have seen credit to the private sector contract, while the public sector still receives funding; and (e) the LTD coverage for Greek banks is getting worse.

Tuesday, April 12, 2011

Greece’s GDP in 2010

In 2010, Greece’s GDP fell from €235 billion to €230 billion, a 4.5% decline in real terms, marking the country’s worst recession since 1974. If GDP falls by another 3%, as forecasted in the government’s budget, then it will end up at around 2005 levels. In this post, I want to disaggregate the decline in output and understand its main drivers and characteristics.

Before dissecting the numbers, I want to recall an earlier post dissecting Greece’s growth record since 2001 (see here). That analysis had led to these conclusions: (a) Greece needs to correct its massive current account deficit; (b) investment is too low; (c) employment in agriculture remains too high given sectoral output; (d) industrial production is below other European countries; and (e) an over-dependence on wholesale trade exposes Greece to over-cyclicality in output. In reviewing the GDP record of 2010, it is important to ask whether 2010 amplified or helped correct these trends.

In 2010, GDP fell mainly due to a drop in government spending and investment. A shrinking trade deficit contributed positively to output, while private consumption remained flat. For the most part, these trends followed earlier patterns. A lower trade deficit boosted output in both 2009 and 2010, although the deficit was still the highest in Europe. Investment fell in both years as well, but less so in 2010 than in 2009. Consumption, the main driver of growth over the last decade, fell in 2009 and was flat in 2010. Only government spending registered a major reversal, switching from growth to a decline in 2010.

These trends are no surprise: a recession should shrink spending and it should also help narrow trade imbalances. Yet the continuous drop in investment is worrisome. In 2010, Greece’s investment share of GDP was the second lowest in Europe after Denmark. To reach this position, Greece has seen a steady decline in investment since 2003: in that year, Greek investment was 25% above the European average (as a % of GDP); in 2010, it was 21.5% below. In nominal terms 2010 investment was below 2001 levels; in real terms, it was 24% down. The collapse in investment is a major challenge that the country will need to reverse.

Looking at investment more closely reveals the following dynamics. Most of the volatility in investment comes from housing and from metal products and machinery: housing investment peaked in 2006 and has since fallen by more than 55%, while metal products and machinery investment peaked in 2008 and has since declined by 36%. Other constructions and transport equipment have both seen peaks and troughs that have left them at roughly stable levels in nominal terms.


Finally, the numbers at the industry level show that agriculture, industry and financial intermediation and real estate all grew in nominal terms in 2010, although their growth was meager (0.1% on average). Almost 60% of the decline came from public services (which was down -8%), while the rest of the drop came from trade, including tourism and transportation (-2.8%), and from construction (-12%).

Putting all these numbers together reinforces the picture that I sketched out in the past: Greece’s trade deficit, at 8.5% of GDP, has fallen but remains very high, while investment is not just low but in fact collapsing. The combination of a necessary decline in government spending with the high exposure to cyclical business (travel, wholesale trade) amplify the country’s economic decline.