Wednesday, November 28, 2012

Greece - still not a full solution

Markets have taken the latest Greek debt machinations in their stride.  Perhaps that’s because there are bigger things to lose sleep over at the moment, such the US fiscal cliff.  Regardless of the reason, Greece still matters so long as the risk of contagion from a messy default lingers.

Measures announced yesterday should go a reasonable way towards reducing Greece angst for a little while longer.  At issue was the 2013 Budget showing a debt to GDP ratio reaching 190%, well in excess of the expected peak of 167% expected just in March.  That’s due to the recession being deeper than expected on the back of ever more austere budget measures which were on the back of the recession being deeper than expected....and so on.

So if you thought the target of reaching a debt to GDP ratio of 120% by 2020 was dubious in March, it had just become a whole lot more dubious.  Fortunately the “troika” (the European Commission, the IMF and the ECB) have realised that if Greece is to move to a position of fiscal sustainability and economic viability, a more balanced approach is required.  The authorities therefore agreed to give Greece an extra two years to reach it primary budget surplus target of 4.5% of GDP, shifting the data out from 2014 to 2016.  That’s a positive and pragmatic step forward.

That left the issue of how to fund the budget gap that extension would create and to move the debt to GDP ratio to more sustainable levels over time.   For that a number of solutions have been developed to achieve medium-term sustainability within tight political (other Euro zone countries) and operational (ECB) constraints.

The measures include a reduction in the interest rate Greece pays on its debt and extension of the debt maturity.  Also, national central banks are to repatriate their profits on ECB holdings of Greek government bonds back to Greece.  The Eurogroup Communique also makes reference to Greece considering debt buy-backs.  The speculation is that the EFSF will make cheap funds available to Greece to buy back outstanding debt at 35% of face value.  The IMF is withholding its share of the next tranche of the bailout funds until it sees more detail on this part of the plan.

As a result the Greek debt to GDP ratio is expected to fall from 175% of GDP in 2016 to 124% in 2020 (previously 120%) and to “substantially lower” than 110% by 2022.

The bit I still worry about is the high degree of structural reform required in Greece, particularly with respect to the labour market, if it is to meet the growth projections underpinning the Budget forecasts.  It’s hard to see much progress on that front while the country remains in deep recession.  So while this package of measures parks the Greece problem for a little while by establishing a modified fiscal trajectory, it is not yet solved.