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Wednesday, May 25th, 2011

Improving the long-term fiscal outlook posted by Ross Dawkins

 

The Pact for the Euro requires concrete yearly commitments towards shared goals of fiscal sustainability and enhanced macroeconomic performance. 
 
Now, I assume that the euro is here to stay (this is, of course, a separate consideration to who its constituent members are). It strikes me that the annual commitments described in the Pact imply a better quality and more transparent discourse in at least some Eurozone countries on these topics than has been typical so far (I think this is very clearly implied by the situation that at least some of those countries are in).
 
So if a country is to stay with the euro, how is to achieve this and to embed these commitments in the national democratic process?
 
One idea that I like is the work by the CPB Netherlands Bureau for Economic Policy Analysis. The CPB reports on the economic impact of the manifestos of Dutch political parties every election. The discussion includes the implications for the public finances (including sustainability), macroeconomic impacts and any proposals in education, science and innovation policy.  The Dutch economy is doing ok and the fiscal position is comfortable - the CPB's work is only one contributor, of course, but I suspect that it's an important institutional development nevertheless.
 
Inevitably, Dutch political manifestoes remain (like the Pirates of the Caribbean Pirates’ Code and political manifestos everywhere) guidelines rather than rules since events will always override plans. Nevertheless, this form of analysis should be a useful tool in heightening discourse on economic matters. An example of the CPB's work (on the 2006 election) is here.
 

The CPB is an independent body (albeit within a Government ministry) and its work is highly respected in the Netherlands. Can other Eurozone members find or found equivalents?

 

03:58 PM | Permalink

Thursday, May 19th, 2011

The next head of the IMF posted by Ross Dawkins

 

It strikes me that the justification being used to continue the "tradition" of the IMF head being European - the problems in the eurozone - is actually a very good argument against a European candidate.

A meritorious candidate who can sell the need the change within the affected countries of the EU and then sell the reality of those reforms to the rest of the world is what is needed.  I see no good reason why this needs to be a European: there could even be a benefit in it being not being a European in that any suspicions of a "put up" job would be substantially mollified.

European countries represent a substantial minority amongst the shareholders of the IMF - no more, no less. Europe and the USA will sooner or later need to adjust to not having a lock on the top jobs at the IMF and World Bank (respectively). Indeed, the first of the two to accept that might even reap a small dividend from it.

 

01:36 PM | Permalink

Wednesday, May 18th, 2011

Greece is still the word posted by Ross Dawkins

  

“This is the life of illusion
Wrapped up in trouble laced with confusion
What we doing here? “
 
[Extract from Grease, copyright of Frankie Valli]
 
There is some convergence amongst commentators that a 50% haircut on Greek debt is inevitable. 
 
I am not yet fully convinced that this scale of debt re-structuring is inevitable — although this does put me on the side of the ECB against the market (not perhaps a comfortable position, as in the end the market will always win - but the market may change its mind first!). Having thus made myself sufficiently a hostage to fortune on this, there are a few aspects to my thinking about re-structuring that I want to discuss here. 
 
First, there is the potential for moral hazard: the idea that post-restructuring Greek politicians will lack the appetite to continue reform. Greece’s finances are not sustainable without major structural reform, full stop — i.e. without such reform, there will be a further restructuring at some future date. 
 
To the extent that the capital markets appreciate this, then Greece will have to continue to rely on the rest of Europe for financial support. Capital markets tend to be wary post-default anyway as psychological compensation for the inadequate wariness beforehand. On this basis, a lack of substantial reform in Greece would make for a huge challenge to the continuance of Greece’s membership of the Eurozone (maybe even to the Euro idea itself).
 
Such a large haircut would also put Greece’s debt: GDP ratio below that of — at the least — Ireland, Italy and Belgium. This may be technically justifiable but would be blatantly easy to make political capital of as a slippery slope to haircuts all round by “sceptics” of the euro or the EU. The rest of the Eurozone would, I suspect, see it as simply overly-generous to Greece.
 
Another political fear (which should translate through to political resolve) is that Greece’s government has access to more assets than it has so far committed to sell, i.e. that Greece has a liquidity problem rather than being simply bankrupt. In a corporate re-structuring, one would expect to see the value of any such assets realised for the benefit of creditors (potentially at fire-sale prices). I would expect to see some such commitment to creditors to be part of any re-structuring of Greek debt.
 
Last — but not least — there is the impact upon the Greek banking system and the potential for contagion. On the one hand it is widely recognised that Greek banks have large holdings of Greek government debt so that a restructuring in the latter will imply major problems for the former. On the other hand, treatment of this tends to be limited: “…and the Greek banks will need to raise some capital, etc” without identifying what this means or how this is going to happen.
 
Let’s begin with some context. Non-Greek banks have reduced their exposure to Greece significantly from a peak in about in June 2008. The reduction is quite large — a peak of $293 billion spread amongst all European banks (as defined by the BIS) — this extends beyond the Eurozone and indeed the EU) to $136 billion at December 2010. A further reduction in the several months since then seems more than likely. 
 
Of the December 2010 total, $57 billion is with French banks and $34 billion with German ones. Of the rest $10 billion is with Portuguese banks (intriguingly little changed from peak) and a further $14 billion with British banks. The rest is fairly well spread about.
 
This is within the context of a general reduction in cross-border claims within the European banking system post-credit crunch. Such claims increased dramatically in 2005–07. In contrast, claims by European banks on Brazil, China and India are at an all-time high. Similarly, foreign claims by US-based banks are almost at an all-time high. So there is a European dimension to this and Greece has seen much retrenchment than most.
 
Not all of these claims relate to Greek Government debt: Robert Peston estimates about $20 billion each for French and German banks.
 
If that’s right there is another $14 billion of government debt held by credit institutions based elsewhere. If the exposure of British banks is proportionate to their overall share of all claims, then perhaps they held $5 billion as at the close of 2010.
 
Greek banks hold a good deal (€48 billion in bonds and another €13 billion in loans). Their capital and reserves (excluding bad debt provisions) were in aggregate €29 billion at the end of February 2011 (according to the National Bank of Greece).   So a 50% write-down on the bonds alone would be locally apocalyptic and carry some contagion risk as a further raft of claims on Greece relates to its financial sector. However, this has also reduced dramatically, so that the claims by European banks on Greek ones stood at $11 billion at the end of 2010. The chart below illustrates the scale of change here. 
 

Source: BIS
 
This is relatively small beer compared to the direct impact but may have consequences on Greek corporates that then throws all other claims into at least some doubt.
 
In any event, a re-structuring would need to factor in an immediate recapitalisation of the Greek banks affected to avoid wholesale loss of confidence by customers and creditors that would be disastrous for the economic recovery of Greece and its removal from the life support being offered by the rest of Europe. 
 
Needless to say this recapitalisation is not going to be by the Greek government (nor would nationalisation really solve the problem of meeting internationally-set capital rules - it could do little more than create some accounting book entries). One possible avenue would be the acquisition by international banks, in which case it is a question of value (i.e. would be buy and at what price given the cash required to re-capitalise them) and (to a lesser extent) of the political acceptability of this in Greece. It may be that a holding vehicle (guaranteed by the ECB, say) would be a necessary intermediate step. 
 
This would be extremely messy but the firewall around any re-structuring would need to be extremely potent to avoid contagion to the global banking system. It would also need to be in situ to avoid a re-run of Lehman Brothers.

 

02:38 PM | Permalink

Greece: In Time of Storm posted by Ross Dawkins

[This is from “The Complete Poems of Sappho”: translated by Willis Barnstone (and the reproduced translation is his copyright), published by Shambhala Publications, Inc.]

In Time of Storm

Brightness
 
And with good luck
We will reach harbour
And black earth
 
We sailors have no will
In big blasts of wind,
Hoping for dry land
 
And to sail
our cargo
floating about
 
Many
labours
until dry land

I have noted previously that the commitments made by successive Greek governments to the Greek people are fundamentally out of kilter with the current growth potential of their economy.  Even a substantial haircut now would not change this: a further, future default would still be likely without substantial reform in Greece.  The cost of financing Greek sovereign debt will remain high until there’s evidence of such major reform actually achieving results.

The market has little interest in funding these commitments even on a short-term basis — and this interest will disappear completely in the event of default.   

And Greece is not about to grow its way out of trouble (the positive Q1 2011 GDP performance needs to be seen in the context of past shrinkage).  Indeed, the most recent Global Competitiveness Report published by the World Economic Forum ranks Greece last within the EU27 and 83rd globally (in fact, 139 countries are ranked).  By way of contrast, Sweden and Germany are ranked 2nd and 5th globally.  There’s nothing inherent about EU membership that prohibits competiveness.   

The country is ranked in 125th place globally in terms of labour market efficiency.   Respondents to the WEF’s survey ranked such labour market rigidities as the third most problematic factors to doing business.  Inefficient government bureaucracy and corruption were one and two on the list.


Greece’s economy is neither innovative nor is it low cost (even within the EU).  So there is a lot required from Greece in terms of change.

My belief is that there is increasing frustration elsewhere in the Eurozone at the progress to date, after a briefly promising start.  So looking back to the poem from Sappho at the beginning of this article I now explain my belief as to its relevance: Greece’s crew have shown a lack of will to date and they will continue to be buffeted by the storm until adequate recognition is given to the effort necessary to escape it.

 

02:36 PM | Permalink

Friday, May 13th, 2011

Greece: it’s worse than you thought posted by Ross Dawkins

It has been apparent for some time that Greece’s finances are a complete horror show (and not in the cool, Clockwork Orange sense).  It’s equally obvious that Greece will not be able to tap the market for funding (at least not at the level it needs) either in the short-term or the medium-term.

Given that the immediate problems are sufficiently pressing, the long-term sustainability of Greek finances is simply not part of the current debate.  This is a perfectly rational approach for bond traders.  If your investment horizon is measured in weeks then the latter simply does not matter — your concern would be a change in the way your peers in the market perceived this.  

However the size of the long-term fiscal gap and the scale of the intergenerational flows implied by the commitments made by successive Greek governments are of interest, I think, in terms of the structural reforms necessary in Greece and the nature of any re-negotiation in its outstanding obligations.  They are also indicative of how far ahead Greece’s political promises to itself have overreached of its economic capacity.  

The following chart highlights the long-term problem. (This chart is drawn from the “Sustainability Report 2009”, published by DG ECOFIN, which assessed the fiscal sustainability of EU Member States out to 2060).  The closer a country is to the top right-hand corner, the greater the adjustment required.  The long-term projections make (necessarily heroic) assumptions about demographic change and the impact of ageing populations.  Over-generous and underfunded pension promises put Greece (“EL” in the chart) high up the vertical axis.  Our current fiscal predicament pushes the UK out to the right. 

 © DG ECOFIN

Whilst the Greek government has made some progress on unmaking past political promises the starting fiscal position is (much) unhealthier than that presented in the chart. 

In short, Greece’s fiscal position is no more sustainable long-term than it appears today (and possibly less so). And remember that this is a structural problem: simply re-scheduling Greece’s debts or even a write-off of part of them would not alter Greece’s position on the above chart.  Further action to both promote economic growth and to undo past political pension promises are essential components in any rescue plan that is to be successful. 

 

 

08:57 AM | Permalink