Eu & Greece :is Time Running Out For Greece?

Charles Malize
April 20th 2010
Challenges
Greece is a member of the European Union. Its national debt currently stands at approximately 300bn euros ($400bn). This is considered excessive and as a result, potential investors are reluctant to lend the country anymore money. The ones that do lend demand a higher premium. This predicament is particularly troublesome as Greece must refinance more than 50bn euros ($66. 7bn) in debt for 2010.
Following the governments’ excessive borrowing in recent years the country indulged in a spending binge that put a significant strain on the economy. This is with public spending and public sector wages raging out of control. Together with the global financial meltdown which the country was inadequately prepared to handle, economic reality set in. The country in the last two months has been scrambling to find ways to rescue itself from its excessive debt. Its budget deficit is regarded as very high under the EU (European Union) standards. Greece’s budget deficit has soared to almost 13 percent of the Gross Domestic Product.
Last week the Euro zone approved the details of a 30bn euro ($41bn) emergency loan package to assist them out of their debt crisis. Greece has not indicated if it will accept the funding from the EU/IMF (International Monetary Fund). The structure of the funding takes into account a three-year financing program at interest rates of about 5 percent. The interest rate proposed is significantly less than the 7 percent the Greek government presently compensates investors to raise money on the open market.
Nonetheless, because of the ensuing measures that are expected to follow the loan, the Greek government is reluctant to accept the funding package, and yearns for a package of austerity measures to cut its budget deficit.
Athens is aware that the conditions for providing these loans can prove punitive and difficult to swallow. This could translate into a prolonged recession as the economy contracts and consumers save. Governments don’t like this. Greece has shown reluctance to pile up additional debt and prefers to go the avenue of increased taxes and massive spending cut. The country hopes that a broad package of stern economic measures should assist it to reduce its debt levels and boost confidence in its government debt.
Some market observers agree that the EU position on Greece has been a disaster. This is a serious sovereign debt issues that requires serious attention. At the beginning there was some denial from EU leaders of the seriousness of the crisis in the region, with Germany and France turning a blind eye. As time progressed, it became obvious Greece needed the right fiscal and monetary stimulus to absolve it from its problems.
Borrowing cost has remained a major concern as investors remain skeptical that the Greek government’s program of spending cuts and tax rises, will be enough to restore confidence. This program is being ostracized at home. Following Greece’s plan for budget cuts, there has been a series of widespread public protests. Two prominent unions in the country have identified the austerity cuts as “anti-popular” and “barbaric”.
Greece has outlined plans to cut its deficit to 8. 7 percent in 2010, and to 3 percent or less by 2012. The approved austerity package is an attempt to save 4. 8bn euros ($6. 4bn). The measures taken include a freeze on public sector workers’ pay, a raise in taxes and an increase in the average retirement age to cushion liquidity issues in the pension system.   Also, there is a proposal to raise petrol prices. These could translate into the country raising money by itself, rather than rely on financial assistance from the eurozone and the International Monetary Fund.
Sovereign Ratings
Greece seems to have fallen off the cliff and the rest of the “PIIGS” (Portugal, Ireland, Italy, and Spain) look dreadfully vulnerable. On the currency front, the euro has weakened against a basket of major currencies including the US dollar.   Furthermore, the rate at which the Greek government borrows money on the international capital markets has augmented.
Greece’s next payment on its sovereign debt becomes due in May and it needs to pay approximately 11bn euros ($15bn) to meet its financial commitments. In an effort to raise money, its success in auctioning a 1. 2 bn euro package of treasury bills last week helped gain confidence among investors. It lessened the pressure of asking its eurozone partners and the IMF for help. This appears a short term fix with the expectation it will have no choice but to take advantage of the loan package proposed by the eurozone and the IMF.
Last week, saw Greece’s government debt down-graded by the rating agency Fitch, from BBB+ to BBB – . The latter (BBB-) rating is noteworthy, as this is the lowest rating that meets the criteria as an investment grade bond with Fitch. The pressure is on. A further downgrade by Standard & Poor and Moody’s could prove disastrous for Greece as most influential investment houses will not be allowed to invest in their treasury bills. Greece is currently rated BBB+ by Standard & Poor’s and A2 by Moody’s.
The loan package
From the outset, EU’s hopes of bailing out Greece seemed lost until the IMF stepped in and pledged funding. The situation was becoming intricate following the EU reluctance for a bail out. This position with the EU did not bode well for their credibility. The likely outcome is a similar crisis that will have a ripple effect in Italy, Spain and beyond.
The EU was forced to act after its initial proposal of a 22bn euro support package, agreed to in March, failed to convince investors that Greece will have the backing of their euro zone allies. Lack of detail in the plan left investors unconvinced that the eurozone would fully come to the rescue. The latest offer (30bn euro) is simply a more detailed, and an improved version of the original package that comprises a three-year financing program at interest rates of about 5 percent, less than the rate the Greek government would have to pay to raise money on the open market.
This amount may be enough to prevent Greece from defaulting in the short term but in the long term the problem of solving the debt crisis still remains. It gives the Greek government breathing space in the interim but fails to solve their long term issues. My view is that potential investors still perceive the Greek economy as weak and with time, Greece will come “hat in hand” to the EU asking for further bailout funding.
Assuming all is contained going forward, a major issue for Greece will be how to reshape the sovereign debt when the current distress has subsided.
Domino Effect
Questions about high levels of debt in Greece and its borders have raised eyebrows globally. The problem in the region: surging debt, poor capitalism, financial institutions sitting on a lot of assets that cannot be priced and the continuous weakness with the euro.
Also, the region could be heading into a stagnated recession as the financial crisis in Greece spiral out of control. The fear is an “L” shaped recession (prolonged) that may depress markets for extended period. These countries have to contract their economy to be able to satisfy their sovereign debt exposure. Beyond Greece are Portugal, Ireland, Italy, and Spain that seem to have the same liabilities. These countries are experiencing a synchronized contraction that requires a strong policy action to restrain the problem.
The IMF decision to step in with regards to Greece before the EU, showed a distinct weakness within the European Union. There seemed to be a policy stalemate within the EU over Greece due to the fiscal and monetary issues that are spread through sixteen member states. During the recent global financial crisis, the EU struggled to find a comprehensive approach in dealing with the crisis for this reason. What’s more, there is a nominal budget for the bloc. That raises the stakes for not having a joint plan in the event of the development of a major financial crisis occurring within member states.
There is anxiety that Greece’s troubles in the international financial markets will trigger a domino effect, on other weak members of the euro zone. These countries are facing difficulty balancing their accounts. The rating agency, Fitch has already downgraded Portugal’s credit rating from AA to AA-.
Due to the massive fiscal deficits in the region these countries face a downgrade on their sovereign ratings that will make it difficult to raise money in the international markets.
Sovereign ratings appear to be cracking amid financial crisis in the region. There is the possibility of insolvency in some of these countries and this is the danger.
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