Wednesday, January 7, 2015

Greek angst

Greece is once again causing financial markets a degree of consternation.  The failure of the Greek parliament to elect a new President has resulted in the calling of a snap election scheduled for January 25th.  This has once again triggered concerns about the possibility Greece exiting the euro zone.

2014 saw relative financial market calm towards the euro zone.  That’s not to say there was nothing to worry about but market concern about weak output growth and low inflation was soothed to a significant degree by the pledge by the European Central Bank (ECB) to expand its balance sheet.

That relative calm largely ignored the growing unease, discomfort and possibly even rage against austerity that has seen the rise of anti-austerity and anti-Europe political movements across the euro zone in recent times.  For that reason 2015 was already shaping up to be an interesting year politically in the euro zone, even without an early election in Greece.  Elections are scheduled in Spain and Portugal for later this year.  It only seemed a matter of time before markets started to worry the far-left Podermas party in Spain is vying for the lead in political polls.

In Greece the (also) far-left Syriza party is ahead in the polls and seems odds-on to form the next Government, although it appears they will likely require coalition support from the centrist Potami and/or the centre-left Pasok.

During the previous election campaign in 2012 it was the (still) leader of Syriza, Alexis Tsipras, who promised to “tear up” the bailout agreement between Greece and the troika of the ECB, the International Monetary Fund (IMF) and the European Commission, an act that would have resulted in Greece exiting the currency union.  It was arguably that risk within an electorate that, despite austerity, preferred to stay in the euro zone that saw the current government led by New Democracy prevail.

Since then economic growth has turned positive (off a low base!) but the unemployment rate remains worrisomely high at 25.7%.  At the same time austerity measures have included cuts to pensions, reduced unemployment benefit entitlements and healthcare services and new levies on property investment.

In this election voters face a choice of more of the same or a change to a Government led by parties promising softer bailout terms, debt cancellation and the restoration of social benefits.  Syriza is promising higher pensions, free electricity for poor households, subsidised housing and free medicine and hospital care for the unemployed.  This is to be paid for by reduced “wasteful” spending and crackdown on tax evasion. They are also promising a near 50% increase in the minimum wage.  That must sound good to an electorate suffering austerity fatigue and where one in four is out of work.

There are, however, a number of risks for a new Government to manage.  The first is that 80% of Greek debt is held by official creditors.  Add to that the fact the government faces a financing requirement of €24 billion in 2015.  In the absence of an ability to secure that financing from global markets, the Government will remain dependent on those same creditors for that funding.  Default remains an option but that will result in exit from the currency union – a result that, despite austerity, is still not desired by the Greek electorate.

Should exit occur the Euro zone is arguably better placed to cope with it now than it was in 2012, although that won’t stop markets from fretting.  The European Stability Mechanism is stronger, the OMT (Outright Monetary Transactions) is in place, assuming the European Court of Justice doesn’t rule it illegal, and baby steps have taken towards banking union.

The likely post-election result seems to me to be the troika remains in charge and that some compromise will result.  Continued commitment to macro-economic reform and lower new spending than currently being promised will be exchanged for some debt relief in the form of a lengthening of debt maturities and further measures to lower debt servicing costs.

One can only hope, however, that an earlier than expected election in Greece may be the catalyst for a more meaningful conversation about the merits of austerity. It always seems somewhat simplistic to point out, as I have on many occasions, that there are two parts to a debt-to-GDP ratio – debt and GDP.  In the case of Greece and others in the euro zone austerity aimed at lowering the numerator ending up doing more damage to the denominator -  to such an extent that in Greece the ratio now stands at 174%, higher than the onset of the euro zone  sovereign debt crisis.

I also take little comfort from IMF forecasts indicating a drift lower in the ratio over the next few years.  That projection assumes Greece will be able to run primary budget surpluses averaging 4% of GDP over the next five years.  While few have little sympathy for the woes of the Greek populous given past profligacy, that forecast ignores the impossible political challenge of implementing such an austere program in the face of what the leader of Syriza correctly describes as a “humanitarian crisis”.  A different approach is required.