Thursday, August 23, 2012

Don't forget Greece

Amongst the recent optimism in Europe that help is at hand via the European Central Bank (ECB), it would be wrong to forget about Greece.

With the recent election turmoil, the scheduled May 31 review of progress towards Greece meeting its agreed fiscal targets is only happening now.  The Greek Finance Ministry has developed a plan for another 11.5b of fiscal measures to get the fiscal adjustment process back on track.  The troika of the European Council, the ECB and the International Monetary Fund will head back to Greece in early September to prepare its report and recommendations which will most likely go to the October Euro zone leaders meeting for ratification.

The delay in its development and implementation means Greece faces a further 10-20 billion financing gap.  With no new money likely to be forthcoming, that gap is likely to have to be closed within the existing bailout parameters.

In the meantime, Greek Prime Minister Samaras heads to Germany and France this week for talks with Chancellor Merkel and President Hollande.  He will be pushing the line that after a very unstable political period, Greece is back on track as indicated by the new fiscal plan and the fact that the privatisation plan is on track, with some sales expected this year. 

The meeting with Chancellor Merkel in Germany will be the most critical.  Some senior German politicians have recently been speculating on a Greece Euro exit with the vice-Chancellor speculating a Greek exit has “lost its terror”.  We completely disagree.  A Greece exit would still entail significant systemic finance sector disruption.

The problem with a Greece exit is, as is well understood, the problem of contagion.  A Greece exit now would raise the immediate question of, and speculation on, who will be next.   No amount of firewall building will prevent that speculation.  We remain of the view that a Greece exit can only be realistically contemplated when the rest of the Euro zone is stabilised.  That is when structural budget deficits are eliminated, debt levels are declining and the euro zone is growing sustainably.  That is still some time away, probably years.

There has been some suggestion Samaras may ask for a time-extension for Greece to meet its fiscal targets.  We have some sympathy for the argument Samaras may put to Merkel this week.  The fiscal adjustment in Greece has come at considerable cost, both economic and social.  Greek GDP has contracted 20% since the adjustment process began and the unemployment rate is 23%. 

As we have argued many times, the balance between fiscal adjustment and economic growth has been lost.  Putting aside the fact that Greece is the primary architect of its own problems, the question to us seems to be how best to implement a solution that provides a positive outcome for Greece and Europe. Good luck, Prime Minister.