15 Jan 2010

Zoning in on Greece

Bank of Greece, Thessaloniki
(cc) gichristof/flickr

The fiscal crisis between Athens and Brussels puts EU credit and currency problems in the spotlight, Robert M Cutler writes for ISN Security Watch.

By Robert M Cutler for ISN Security Watch

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Greece's economy experienced rapid growth over the past decade with an average annual growth rate of 3.7 percent as against 2 percent among eurozone countries in general. Indeed, prior to the recent parliamentary elections in October 2009, it seemed that the national economy was standing up well against the international financial crisis.

After the elections, however, Greece raised the prediction of its 2009 budget deficit from its earlier estimate of 3.7 percent to 12.5 percent of GDP, over four times the 3 percent limit prescribed by the EU Stability and Growth Pact, which sets norms for its members' national budgets. At the same time, the government revised the size of its 2008 deficit from 5 percent up to 7.7 percent.

The rating agencies Standard & Poor's and Fitch immediately downgraded Greek sovereign debt. Credit default swap spreads, basically the premium of an insurance policy against default for bondholders, immediately spiked to 211 basis points (i.e. 2.11 percent), the highest since March 2009.

On top of this, figures published in November after the parliamentary elections replaced the New Democracy party's government with one led by Prime Minister George Papandreou's Panhellenic Socialist Movement (PASOK), showed that the country's economy was in fact in recession, and that the contraction in the GDP, if not accelerating, was still getting worse with each successive quarter.

Worse still, on 12 January, the European Commission (EC) condemned the country for falsifying data about its public finances and failing to take measures to ensure that its economic statistics were accurate. The outrage is not mollified by the feeling that if Greece were not a member of the eurozone, it may well have already once had to declare bankruptcy in the past. Indeed, suspicions have circulated over the years that Greece even falsified data in order to join the eurozone in the first place.

Brussels has decided not to bail out the country’s economy. In 2008, Greece received €4,700 million ($6.84 billion) in 'cohesion funding' (meant to help develop poorer regions of the EU), which it could conceivably lose in the absence of reform. However, the EU's designated monetary commissioner, Olli Rehn, has stated to the European Parliament that sanctions such as loss of cohesion funding should be only a last resort.

Rehn rejects categorically the possibility of Greece's voluntary departure or expulsion from the eurozone, even if it fails to correct the problems in its public finances. Yet if Greece's exit from the eurozone is not (yet) officially entertained by anyone, this may be because such a move would threaten putting the eurozone's own cohesion under question.

Early warning signs

Even before the present crisis, according to European Commission analyses, Greece was the lowest-rated country in the eurozone due to its increasing budget deficit, decreasing competitiveness and increasing public debt (which is about two-thirds of total external debt and by itself equal to one year's GDP).

Accordingly, the IMF had warned in mid-2009 that any medium-term recovery in Greece was likely to be hampered by weak competitiveness, large external imbalances and the need to cut the fiscal deficit to limit risks. That situation can only worsen now, as economic slowdown exacerbates of the burden of the country's euro-denominated debt. The resulting wave of private defaults could even spill over into the public sector.

New EU President Herman Van Rompuy has stated that Greece’s problems were of concern to the whole EU, and he has expressed confidence that Greece was beginning to address those problems. By this he means to endorse the new government's plan to grant its statistics office full independence and create a commission to investigate its shortcomings with the assistance of Eurostat, the EU's statistical office.

The new government's finance minister, George Papaconstantinou, suggests that a combination of failure to enforce tax-collection measures combined with pre-election spending accounts at least in part for the newly reported increase in the state budget deficit. His good will and good faith may be assumed, given his background as an economist and professional work in the OECD. The problem is that, given past experience, it is difficult for anyone in Brussels to take seriously whatever new figures he announces.

'Inherent in the system'

The IMF has already within the last year provided such help to countries in the region afflicted by similar problems, including EU members seeking to join the eurozone such as Latvia, and also non-members such as Iceland. Consequently, there is extreme political sensitivity on all sides over the IMF mission that is visiting Athens this week, ostensibly to provide technical assistance in the reform of the taxation system and statistical agencies.

As the Financial Times' Martin Wolf explained last week, the crisis in Greece not only cannot be organically separated from the crisis in the rest of “the eurozone's periphery” (including Ireland, Italy, Portugal, and Spain), but moreover is “inherent in the system.”

Those countries, in Wolf's analysis, cannot easily sustain current fiscal deficits or kickstart private sector borrowing or generate an external surplus. There is no eurozone 'hegemon' to rescue them. Speculation is rife in the financial markets that Greece will ultimately require an international bailout that Brussels has already declined to provide. The IMF is the logical lender. This is why Greece, for all its idiosyncratic aspects, is not a special case but, it is feared, only the tip of the iceberg.