04/27/10
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*****EU reaches a deal on Greece*****
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02.19.10
· Greece - The European Union should be more specific on how it would support Greece in a
crisis, to help lower the highly indebted country's borrowing costs now, Greek Finance
Minister George Papaconstantinou said on Thursday – Reuters
· Greece replaces its debt mgmt chief; Petros Christodoulou will take over from Spyros
Papanicolaou as head of the Athens-based Public Debt Management Agency (Bloomberg)
· Greece - Moody's Reviews For Downgrade Aaa Ratings Of Most Greek Structured
Finance And Covered Bond Transactions - Moody's Investors Service today placed the
Aaa ratings of all except one Greek ABS, RMBS, CLO and covered bond transactions under
review for possible downgrade. Today's rating actions result from an initial assessment of
these highly rated Greek structured finance and covered bond transactions within the context
of the evolving sovereign situation as well as the current economic and financial
environment. Moody's
· Greece - Standard & Poor's Ratings Services today lowered its credit ratings on all 'AAA'
rated Greek securitization tranches to 'AA' on account of its view of increased Greek country
risk.
Greece - Greece says a complex debt deal with US investment bank Goldman Sachs that has come under scrutiny by the European Union was above board and will be explained in a letter
being sent by the finance minister to the European Union. Greece has until today to supply
answers about how it used the transactions NY Post
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Greece
No Short-Term Rest
•The Greek sovereign debt crisis remains intense despite efforts from the Greek government to calm markets. The Greek government keeps reiterating its commitment to sort things out by itself, by speeding up (or, if necessary, by adding to) the austerity measures announced over the past month. This morning, the labour minister unveiled some details of the pension reform draft, which targets an increase in the effective retirement age from 61 to 63 years by2015. Also, some details of the tax reform have been disclosed today.
•Moreover, recent fiscal data provided some support to the government. According to very preliminary data, tax revenues increased in January by 15% YY, versus an annual target of +7% YY for 2010, thanks to the one-off levy imposed on businesses. Broad-based hikes in tax rates (e.g., alcohol and tobacco products, real estate properties, fuels) have been implemented since last month: these, we reckon, should be able to keep growth in tax revenues quite buoyant for the rest of this year. But, spending cuts is what markets and EU are asking for to heal the Greek public accounts.
• The European heads of state – meeting in Brussels on Thursday – will probably discuss extensively the Greek situation and the feasibility of any form of external financial support for a euro member state. As we discussed in the Euro Weekly, we think a joint action among euro area governments is likely the only feasible solution for emergency support (see Euro Weekly “No Quick Fix
For Fiscal Problems”, 5 February 2010). However, we suspect that a clear plan has not been designed yet, given the large political problems associated with it for other Eurozone governments. So we think it is unlikely any detailed plan will be spelled out on Thursday – let alone any effective action taken. Supportive statements and hints at possible action plans may be the only outcomes we get from the EU Summit.
• At the same time, a 24-hour strike has been called for tomorrow by the public sector union and we think it could be the first in quite a long series. Public sector workers have been the most affected by the spending cut plans of the government, even though the overall tightening package remains tilted towards higher tax revenues. Last week, the government announced a wage freeze for the whole public sector. Public spending on wages has been on a constant
uptrend in Greece in the past decade, as opposed to a mild downtrend in the rest of Europe. Strikes have also been planned by the private-sector trade union for the end of this month.
• On the other hand, an opinion poll over the weekend showed that support for the government from the general public remains quite high. 60% of the people surveyed said they back the Stability and Growth Programme presented last month, and 70% of the respondents agree with the cuts in the public sector wage bill. However, 70% are against the fuel tax hike (also announced last week) and 60% are against the increase in the retirement age. Overall, we think demonstrations will continue in the short term as the magnitude of the fiscal effort implies almost all social groups will, to some extent, be affected by the tightening measures. This will likely weaken further the government’s credibility in delivering the announced reforms and it will keep market nervous.
All that said, we think that the chances of a default event remain fairly small. The knock-on effect on the rest of Europe – especially on the other weakest links in the Eurozone – would be significant. In this respect, there is a lot of speculation on who is ultimately holding the Greek sovereign risk. The World Bank dataset on external debt shows that in Q3 09 77% of the outstanding debt of Greek general government was held by foreign investors. This is a much higher share than in other Eurozone countries (e.g. Spain: 68%; Italy:
47%).
Data from the BIS can provide an additional insight, by showing major international banks’ claims on foreign countries. Figure 1 shows the exposure
of the BIS-surveyed international banks towards Greece by nationality of the reporting bank, while Figure 2 shows the exposure of all BIS reporting banks to the public sector in Greece and in some other Eurozone countries.
Although the BIS data suffer from many caveats – like they only include banks, they show the exposure to the public sector as a whole not just general government – they still provide some useful information on the diffusion of Greek sovereign risks in international investors. They suggest that French and Swiss banks have the largest exposure to Greece in absolute terms, although these data do not distinguish between exposure to the Greek government or the
Greek private economy. In general, more than 80% of banks’ foreign claims on Greece are from European banks. Figure 2 shows that more than 50% of the foreign banks’ claims in Greece are towards the public sector – a percentage much higher than for other Eurozone countries. If we make the assumption that the sector breakdown is similar across banks of different nationality, these data
suggest that European banks hold a large share of Greek debt, with French and Swiss banks having the largest Greek sovereign exposure. This means that other European countries – and in particular their banks – would bear a sizable cost in case of a default event on Greek debt.
Citigroup Global Markets Giada Giani
Greek fiscal consolidation: painful, but not intolerable
• Significant fiscal tightening in the coming few years
• Greek GDP likely to stagnate over coming years
• Probability of default or debt restructuring very low
None of these options would be painless in macroeconomic terms, because the underlying imbalance between
public spending and taxation needs to be corrected. At present, no one in the rest of the region is willing to pay higher taxes on a permanent basis to fund the current level of Greek public spending. Our central view is that Greece will be able to achieve the necessary fiscal adjustment without resorting to outside financial
help. The scale of the fiscal adjustment needed is very large, but it is not beyond the bounds of what could be achieved. Importantly, the Greek government has outlined a program that targets an appropriate amount of fiscal adjustment. The European Commission has issued a favorable opinion, albeit with significant concerns about the risks of the deficit targets not being met and only after the Greek government announced some additional fiscal tightening measures. There are clearly implementation risks with the program; it will be important to watch the passage of legislation through parliament, the response of the population, and the monthly data on the fiscal position of the government.
Making an assessment of whether the Greek program is delivering or not will take some time. More pressing is the issue of whether financial markets will allow that time to pass. We believe they will; if not, the Greek government would resort to outside financial help. We believe this would be forthcoming, most likely from the EU and the rest of the Euro area, albeit with significant conditionality attached to ensure that an appropriate fiscal adjustment still took place. But, we do not believe that there is a fundamental solvency issue—in the sense that the required fiscal tightening is so large that it would be intolerable—so, even if there was a
request for outside financial help, we would not expect this to lead to a debt restructuring. It is important to recognize that debt restructurings tend to be very painful from a macroeconomic perspective because the underlying fiscal imbalance still needs to be adjusted, losses are inflicted on bondholders, and future borrowing costs tend be much higher. It is clear that a debt restructuring is not an appealing option for either Greece or the rest of the Euro area.
The required fiscal adjustment
The market pressure on Greece suggests that we are close to a limit in terms of the amount of debt that can be issued. This suggests that the government needs to act swiftly to implement measures to stabilize, or even reduce, the debt to GDP ratio. Although borrowing costs have risen at the margin, the key issue is the size of the primary deficit. Even if borrowing costs were equal to the pace of growth of nominal GDP, something that is unlikely in the coming years, a primary deficit at last year’s level of 7.7% of GDP would push the debt to GDP ratio up significantly. So, the immediate issue is to significantly reduce the primary deficit.
This is exactly what the Greek Stability and Growth Program seeks to achieve. The program aims to reduce the primary deficit from 7.7% of GDP last year to 3.5% of GDP this year, to a broad balance in 2011, and to primary surpluses of 2.6% in 2012 and 3.2% in 2013. Assuming that ultimately nominal growth in Greece is broadly equal to average borrowing costs, a primary surplus would lead to a decline in the debt to GDP ratio, albeit from a peak somewhat higher than the current level.
Around 40% of the fiscal consolidation in the Stability Program takes place on the expenditure side: a civil service hiring freeze this year and only one in five retirees being replaced from 2011; a 10% cut in non-wage benefits; and a 10% cut in operating expenditure at the ministry level. There will also be measures to tackle the pensions problem. Meanwhile, around 60% of the fiscal consolidation takes place on the tax side: the abolition of tax exemptions; the reintroduction of progressive taxes on large properties and inheritances;
a one-off special levy on corporates; higher excise taxes; the introduction of a capital gains tax; and changes to reduce tax evasion and avoidance.
If we measure the fiscal drag as the change in the cyclically adjusted primary position, it is worth 5.1%-pts this year, 3.2%-pts in 2011, 2.5%-pts in 2012, and effectively nothing in 2013. This represents a cumulative tightening over hree years worth 10.8%-pts of GDP. This would represent a very large adjustment, larger than any Euro area country has achieved in the past over a comparable period of time. It is also somewhat more aggressive than the Irish plan, which aims for a smaller overall improvement achieved over a longer time horizon. Nevertheless, in our view, while the Greek program is very ambitious, it is not beyond the bounds of what could be achieved.
Throughout this crisis, we have argued that the issue is one of political will rather than economic feasibility. Any assessment of the impact of the fiscal tightening in Greece on economic growth requires an assessment of the appropriatecounterfactual—what would Greek growth have been inthe absence of a fiscal tightening—and an assessment of the magnitude of the fiscal multiplier.
Regarding the appropriate counterfactual for Greek growth, a key issue is what will be happening in the rest of the Euro area. We have a relatively upbeat view on the growth outlook in the Euro area over the coming years as exports regain the ground lost in the recession and as domestic spending on inventory and capital equipment recovers from depressed levels. There will be some fiscal tightening in the Euro area as a whole, but it will not be large—the areawide primary deficit last year was only just over 3% of GDP— and the drag on the fiscal side will be offset to some extent by the persistence of an easy monetary stance. We thus anticipate Euro area GDP growth averaging around 2.3% ar between now and the end of 2013. The easiest
counterfactual to assume for Greece is that in the absence of fiscal tightening, Greek growth would move in line with the Euro area average. It could of course be higher or lower. On the one hand, growth potential in Greece is higher than in the Euro area as a whole; on the other hand, some of the post-recession cyclical dynamics will be weaker in Greece because the recession was shallower, and Greece has lost
competitiveness relative to the rest of the region. In general, fiscal consolidation will be a headwind to
growth, unless it triggers a significant move up in private sector confidence, a significant decline in interest rates
(easier monetary policy or lower long-term yields), or a significant fall in the currency. For an individual Euro area economy like Greece, monetary policy cannot mitigate the local fiscal tightening and its nominal exchange rate cannot decline to provide a competitiveness boost. However, in an economic union like the Euro area, some of the impact of domestic demand weakness in an individual country will fall on foreign producers via weaker imports. Given all of this, it [JP MORGAN]
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