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Tuesday, December 15, 2009

Europe Needs Action Not Words From The Greek Finance Minister

by Edward Hugh: Barcelona

“Today our biggest deficit is that of credibility.In the last years Greece lost all traces of credibility, which is why international institutions, partners want to see actions.” Greek Prime Minister George Papandreou
As the Economist points out, and as I personally can confirm (since I am constantly having to alter and update my excel sheets), Greek government statistics are notoriously unreliable - indeed, I would say that along with the Bulgarians the Greek statistical agencies are the joint worst in the entire EU. But rarely can the numbers have seemed more erratic and subject to such sharp revisions as they have been in recent months. Following the election of the new government in October (who obviously decided to get as much of the bad news out of the way as quickly as possible) we suddenly learnt that far from having been being "spared" the worst of the global economic contraction, the Greek economy in fact entered a period of negative growth in the first quarter of 2009 (shrinking by 0.5% on the quarter instead of growing by 0.3% as the stats office had previously "estimated") wherein it is has subsequently remained. And of course given the size of the correction the Greek economy is now entering it is likely the economy will stay in this mode for some considerable time to come. And as if that wasn't shocking enough, the forecast for this year’s budget deficit more than doubled overnight, from 6% to 12.7% of GDP.

But this problem has a history, and quite a long one. The 2008 general government deficit as notified by the Greek authorities on 21 October to the EU Commission was put at 7.75% of GDP (up by 2.75% percentage points from the earlier estimate of 5% sent in April). But even this version was found to be deficient, and Eurostat specifically expressed reservations about the figures, largely due to the inclusion of a one-off capital expenditure item of around 1.25 percentage points of GDP mainly connected with public hospitals arrears to paramedical and pharmaceutical suppliers.

Moving forward, the official public deficit estimate for 2009 stands at 12.75% of GDP, as compared with the agreed budgetary target of 3.7% of GDP included in the January 2009 update of the EU stability programme. The EU Commission also estimate (in their November forecast) that under a no-policy-change scenario assumption and on the back of the discontinuation of the one-off expenditure item which has in fact been repeated in 2009, the headline deficit is set to remain above 12% of GDP in 2010 and then to continue to increase, exceeding 12.75% of GDP by 2011.

Both falling revenue-to-GDP and rising expenditure-to-GDP ratios will contribute to the anticipated fiscal deterioration. The economic downturn, coupled with high budget deficits, is expected to push debt higher, from 113% of GDP in 2009 to over 135% of GDP by 2011, thus weakening the already fragile sustainability of Greek public finances in the long term.

A Sorry History Of Repeated Failure To Comply

The timeline on this problem looks something like this:

i) On the basis of the data notified by the Greek authorities to the EU Commission in October 2008 the Commission, on 18 February 2009, adopted an Article 104(3) report for Greece on 18 February 2009. Subsequently, and in accordance with Article 104(4), the Economic and Financial Committee formulated an opinion on the Commission report on 27 February 2009.

ii) On 24 March 2009 the Commission, having taken into account its report under Article 104(3) and the opinion of the Economic and Financial Committee under Article 104(4), addressed to the Council, in accordance with Article 104(5), its opinion that an excessive deficit existed in Greece.

iii) On 27 April 2009, following a recommendation by the Commission, the Council decided, in accordance with Article 104(6) of the Treaty, that an excessive deficit existed in Greece in 2007 and 2008. At the same time, and in accordance with Article 104(7) the Council, addressed recommendations to Greece to put an end to the present excessive deficit situation by 2010, by bringing the general government deficit below 3% of GDP in a credible and sustainable manner.

The Council further recommended that the Greek authorities should

(i) strengthen the fiscal adjustment in 2009 through permanent measures, mainly on the expenditure side, including by implementing the measures already announced;

(ii) implement additional permanent measures in 2010, in order to bring the headline deficit clearly below the 3 % of GDP reference value by the end of the year;

(iii) continue efforts to control factors other than net borrowing, which contribute to the change in debt levels, with a view to ensuring that the government gross debt ratio diminishes sufficiently and approaches the reference value at a satisfactory pace; and

(iv) continue efforts to improve the collection and processing of statistical data and in particular general government data".

The Council established a deadline of 27 October 2009 for Greece to take effective action and to specify the measures deemed sufficient to ensure adequate progress towards the correction of the excessive deficit by 2010.

In support of its action the Council noted that a budgetary correction in Greece....

"is also crucial for recovering competitiveness losses and addressing the existing external imbalances. To this end, the Greek authorities should implement permanent measures, including the recently announced measures to control current primary expenditure, including public wages; and urgently implement structural reforms. In particular, the Greek authorities should ensure that fiscal consolidation measures are also geared towards enhancing the quality of public finances within the framework of a comprehensive reform programme, while strengthening the binding nature of its budgetary framework, improving monitoring of the budget execution and swiftly implementing policies to further reforming the tax administration".

That is to say, in depth reforms, and not simply cosmetics are called for.

Following their 11 November ruling the European Commission sent a large delegation of experts to Athens to assess the situation for themselves on the spot, amid strong rumours circulating Athens that the EU was not willing to approve the government's 2010 9.4% of GDP deficit first draft. In reponse to the evident EU reservations the Greek finance ministry circulated on November 20 what they called their revised "final" 2010 budget, with a projected deficit of 9.1% of GDP. But the patience of the EU had by that time become exhausted, and on November 30 2009 the Council of the European Union resolved Greece has not taken effective action in response to the Council Recommendation of 27 April 2009 within the period laid down in that Recommendation.

So we now move on to the next stage of the process, within which the Greek government will again be given a period of time (two months) to advance convincing measures, and another period of time (a minimum of four months and a maximum 16 months) to start to take the required measures (in 4 months) and give unequivocal evidence that they are credibly implementing them (within a maximum of 16, but my reading is that this process could be drawn to a close at any point before then if there were sufficient effidence that agreed steps were not being taken).

The relevant clause governing all this is to be found in Article Seven of the Council Regulation No 1467/97 of 7 July 1997, and runs as follows:

If a participating Member State fails to act in compliance with the successive decisions of the Council in accordance with Article 104(7) and (9) of the Treaty, the decision of the Council to impose sanctions, in accordance with Article 104(11), shall be taken as a rule within sixteen months of the reporting dates established in Article 4(2) and (3) of Regulation (EC) No 3605/93. In case Article 3(5) or 5(2) of this Regulation is applied, the sixteen-month deadline is amended accordingly. An expedited procedure shall be used in the case of a deliberately planned deficit which the Council decides is excessive.

If the country again fails to comply sanctions will be implemented, but my feeling is that this result would be the least important of the consequences. If the Greek government once again fails to live up to its reponsibility, then the internal disciplinary procedures of the Union will have failed, and my guess is Greece would be sent, cap in hand, over to Washington to ask for help from the IMF. If an IMF programme fails to work, well, let's leave that one for another day.......

Papandreou Fails To Convince

Evidently Greek politicians have come under continuous pressure in recent weeks, and Finance Minister George Papaconstantinou has been doing his best to convince the outside world that he means business. In a statement of intent issued at the end of last week he declared that "the fiscal priority for 2010 is a significant reduction of the deficit as a percentage of GDP and containing the increase in public debt which undermine the immediate and long term future of our country."

Prime Minister Pampandreou went further in a speech on Monday in which he spoke of his government's plans to cut the budget deficit from 12.7 per cent to 3 per cent of gross domestic product, the eurozone limit. Greece, he said, was “determined to send a strong message internationally: that we will move ahead with streamlining the economy and promoting a new model for growth.”

Fine words these, although the actual details available leave us far from clear about the precise nature of the deep seated reforms the Greek government is actually contemplating, or the extent to which they realise that significant wage and price deflation will be necessary if the are to restore competitiveness.

The decision to bring forward by several weeks the announcement of the government economic strategy underlines the new sense of urgency which now surrounds policymaking, and comes in response to a 10-day battering of Greek bonds and falling share prices on the Athens bourse. Yet it seems the investing community - the key players in the Greek democratic system now - remain unconvinced, since the yield on the Greek 10-year bond climbed on Tuesday morning 24 basis points to hit 5.70 percent, while the 30-year yield rose 15 basis points to 6.23 percent. Thus the extra yield, or spread, investors demand to hold 10-year Greek bonds instead of German bund equivalents widened 24 basis point to reach 253 basis points, the highest level since April 2.

Mr Papaconstantinou, has effectively been given the objective of reducing the deficit by 3.3% of GDP next year. The reduction is likely to come mainly from increasing revenues (asking businesses, for example, to pay a one-off extra 10% tax on last year’s profits) rather than from spending cuts, although this approach is unlikely to satisfy the Commission, who want long term structural shifts.

In an attempt to head off just this kind of pressure from the European Commission Mr Papaconstantinou has stated he will immediately tackle the structural reforms issue. Among ideas being currently touted are steadily raising the retirement age to 65 for women, opening up a range of “closed” services (from notaries to taxi drivers) to improve competitiveness and introducing five-year rolling budgets for ministries (to curb pre-election spending).

Yet despite the fact that Greek Prime Minister Papandreou promised on Monday that his government will, over the next three months, take all those decisions which "have not been taken for decades", plenty of grounds for scepticism still remain. Mr Papandreou's said many choices will be “painful,” though he pledged to protect poorer and middle-income Greeks. Unfortunately the speech was short on real detail, while the little we have is not impressive.

Talk about obtaining capital to reduce debt via securitization of income from the state’s tax on major property holdings sounds incredibly like simply taking some of the debt off the balance sheet to me, but I'm sure Eurostat will have their say when the time comes.

Whether the announced measures will be enough to satisfy the EU Commission remains unclear. In particular Mr Papandreou's reluctance to follow the example of Ireland, which announced a 4 billion euro correction of its 2010 budget with public sector salary cuts of five to 15%, has had a lukewarm reception from analysts and commentators alike. Greece faces mounting pressure from markets and its European partners to follow Ireland and adopt stronger fiscal measures such as a public sector pay freeze, a ban on civil service hiring and hikes in indirect taxes, to restore competitiveness as well as bring the deficit under control.

In a detailed and useful summary of the present Greek tragedy Kerin Hope and Ralph Atkins quote Yiannis Stournaras, a former chief economic adviser at the finance ministry and now a professor at Athens University as saying: “Wage cuts may not be needed, because the economy isn’t projected to shrink significantly next year, but there should be an immediate freeze on salaries and recruitment,”

I doubt the sort of measures we are hearing about will do that much to convince either Standard & Poor's or Moody's Investors Service, both of whom are currently considering cutting the Greek Sovereign rating. Moody's rates Greece at A1, well above the S&P level of A- (different classificatory systems) and seems willing to give the government time to address the situation.

But a cut by S&P, which is worried both about the amount of deficit reduction and how it is being achieved, would take their rating down into the triple-B category, where Fitch currently have it. ECB board member Lorenzo Bini Smaghi issued a scarcely veiled warning on Monday when he pointed out Greece had just one year to ensure it still had a single-A rating if it wanted its debt to qualify as collateral for central bank lending operations.

The whole discourse from the Greek political leadership gives us an indication of how far one discourse has moved away from the other. While Athens fiddles, the EU Commission continues to demand serious and sustained structural reform. I fear even the most recent of Greek governments only sees a short term problem of deficit reduction, and herein lies the danger, not only for the citizens of Greece themselves, but for all of us who live in the eurozone. This time the situation is for real, and I only wish I could believe that Mr Papaconstantinou and Mr Papandreou were aware of that fact. From this point on there is nowhere left to hide.