Yesterday came some good news for Greece as her Parliament approved plans for a new property tax. Indeed the vote of 155-142 was more comfortable than many had speculated as all members of the ruling PASOK party voted in favour. It is hoped that the tax will yield a revenue of just over 1% of Greece’s economic output as measured by Gross Domestic Product. This has been required because yet again Greece was facing the prospect of missing the fiscal deficit target set in return for the bail out package that she is in the process of receiving.On current trends it looks as though she will find herself with a fiscal deficit of over 9% of GDP this year compared to the target of 7.6%.
Greece still is not fulfilling its side of the bargain
Unfortunately other issues remain unresolved and it looks now as if legislation for them will be delayed until late October. This is a problem because they are part of the deal that will allow Greece to access the next bail out tranche of some 8 billion Euros. So yet again Greece is failing to meet its commitments. The detail of these moves involves a further state pay cut of 20% and a reduction in the tax free personal allowance to 5,000 Euros from 9,500 (with exceptions for those under 30 and over 65).
I also notice that the Greek Finance Minister has called for Greeks to produce more receipts when they return their tax forms in an attempt to deal with tax evasion. Up to now they only had to produce 25% of their receipts and he wishes to increase it to an unspecified amount! Being used to the UK tax system where I collect receipts for virtually all business expenditure I have to confess I was a little bemused by this.
The Private-Sector Initiative for Greek bonds is going badly
Back on July 21st grand plans were set in place for private-sector holders of Greek bonds to take an average 21% reduction or haircut in their holdings. This sort of thing has happened in the past and has been successful, for example Argentina used it as a way out of its debt problem in the last decade. However the Greek version has struggled and an interim deadline of the 9th of September came and went with us nowhere near the 90%+ acceptance that was originally hoped for.
The situation changed fundamentally last weekend with the proposed suggestion that Greece would take a 50% haircut in its debt in early November. Plainly a 21% haircut suddenly looked rather attractive as I pointed out on twitter! Even the most innumerate banker can spot that losing 21% is preferable to 50%. Rather oddly the deal has still showed signs of struggling and whilst there are leaks from time to time that it is approaching 90% participation official sources have refused to confirm this. I think that this is one of those situations where is it had been a success it would be shouted from the rooftops so we can conclude that it is not working. In reality many bond investors seem to be fans of Carlos Tevez.
In the meantime events have moved on as the implications of the fact that Greece is not hitting her fiscal targets and indeed did not hit last year’s either has got the Euro zone revising its predictions. Indeed not only the Eurozone as the International Monetary Fund now forecasts that Greek gross national debt will hit 189% of GDP next year. When you consider that in June it was telling us that the figure would be 172% you can see the scale of the change and in truth it does question their veracity in the past. However if we add in that the IMF now expects the Greek economy to shrink in 2012 by some 2% then there is a clear implication for the bail out package. It will not be enough and will run out. Back in July we were informed that Greece would need to borrow some 172 billion Euros over the next 3 years and the 110 billion Euro aid package was set to help deal with it.
Accordingly not only is the bail out package now too small but even if the 21st of July deal survives the haircut for private-sector investors will have to rise possibly substantially. As they were struggling to get them to agree anyway I would like to wish them good luck with that! So it does not surprise me to see the Financial Times reporting that seven of the seventeen nations involved in the Euro want a change in the terms.
The European Financial Stability Facility: never has so little been touted as so much
This week the EFSF has found itself touted as some sort of behemouth to terrify financial markets. It has been suggested it could go to 2 trillion Euros (an amount recommended by Willem Buiter some time ago) then 3 billion and this morning I have heard Kenneth Rogoff mention 4 or 5 billion. This oddly repeats the hyperbole around plans for further credit easing in the United States this time last year when there was a race to suggest larger numbers! A little reality can be added to the situation by checking the size of the bond issuance that it has made so far and discovering that it is only 13 billion Euros.
Even sillier are the ideas that the EFSF could use leverage to magnify its impact. There are 2 plain flaws with this. The first is that if it only guarantees 20% of sovereign losses (and accordingly leverages itself five times) what happens if losses exceed 20%? If this crisi has taught us anything it is that losses would probably shoot straight over 20% and imagine the instability and panic as we approach 20%. We are back to my image of an unstable lifeboat.
The second is one of logic. When the financial crisis began European politicians were very critical of what they called Anglo-Saxon financial engineering such as securitisations and collaterised debt obligations. As this as a minimum would be a collaterised debt obligation or CDO and in practice would be likely to be what is called a CDO squared ( CDO piled on CDO) i think you can see the hypocrisy and illogic at play here.
Greece’s bond yields still imply default
As I type this article then Greece’s government bond yields are 134% for one year bonds and 70% for two year. Accordingly we can conclude that some form of default is expected and if you look at the prices which are often below 40 as opposed to a par value of 100 they are pricing in more than the proposed 50% haircut.
So if Euro zone officials such as President Barrosso and Jean claude Juncker really belive that Greece is doing well there is plenty of scope for them to invest in Greek bonds and make a profit. Has anybody ever asked them if they have done so?
Greece is reaching the point where defaulting and leaving the Euro may be preferable to remaining
I raise this issue because much of the main stream media tells us that doing the above would be a disaster for Greece. An example of this is an “A-list” Article in today’s Financial Times.
But such an exit would be terrible news for Greece, and equally terrible for the eurozone.
Unfortunately it is full of ill-thought out hyperbole and surmise presented as fact. For example.
Post-exit, the rest of the eurozone and EU would punish Greece by imposing tariffs, while Greece would also lose EU structural funds.
So there you have it, or perhaps you don’t as when the UK left the forerunner of the Euro back in 1992 she remained in the European Union. Accordingly she does not faces tariffs and still receives structural funds when appropriate.
If Greece were to return to a new Drachma then it would be logical for her to default at the same time as otherwise she would be giving herself an even larger burden as much of her debt is Euro denominated. A more competitive exchange rate would be likely to boost her economy and help it recover from its present depression. There would be losses for savers as their savings would be reduced (if they have not had the foresight to move the money out of Greece) but frankly all roads forwards are tough.
When I first began to discuss Greece’s situation some eighteen months or so ago I thought then that the costs of a devaluation would be too high. However as John Maynard Keynes put it “When the facts change I change my mind”. In this instance it may be a sad state of affairs that the alternative of remaining in the Euro now looks worse but it does.
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