Monday, July 4, 2011

Greece: Crisis postponed…again.

Parliamentary votes in Greece last week to endorse a further €28b in tax increases and spending cuts paved the way for discussions on a second bailout to begin and to allow the release of the next tranche of bailout funds over the weekend. This will be sufficient to meet Greek financing needs over the next few months.

However, this is not the end of Greece’s debt problems. All we have had so far is a series of liquidity measures to treat what is essentially a problem of solvency. The only part of the austerity package so far that treats the underlying problem is the €50b privatisation programme, although it remains to be seen how successful that will be.

While moving Greece onto a more sustainable fiscal path (the liquidity, deficit reducing part of the plan) is important, I think we have lost sight of a critical element of any fiscal austerity program – balance.

We have argued for some time now that while fiscal austerity programs would be a critical part of convincing markets that there is a plan to achieve fiscal sustainability, such programs needed to strike the right balance between fiscal consolidation and supporting economic growth. Following the passing of the latest austerity measures, the European Council has revised its forecast for Greek GDP growth this year to -3.75%, followed by 0.6% growth in 2012. I think that’s optimistic.

Political failure to resolve Greece’s solvency problem has simply resulted in harsher liquidity measures being taken. The second bailout needs to allow some time for all of the measures taken to date to have some impact. Indeed the recent proposal from France to rollover Greek debt held by banks into 30-year bonds and a special purpose vehicle will be helpful in this regard, assuming it gains traction.

It’s probably also a good time to remind ourselves that sovereign debt issues in Greece and other European countries are symptomatic of a larger issue – the huge economic diversity that exists within the countries that are member of the European Monetary Union.

It is widely expected that the ECB will raise interest rates again this week. We have talked about that being a risky strategy before. That’s because while Germany may need higher interest rates, higher interest rates and the inevitably higher exchange rate will constrain the necessary export-led recovery in Greece.