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Monday, January 4, 2010

That "Staggering" Greek Deficit Continues To Stagger Onwards and Upwards

by Edward Hugh: Barcelona

Only a few short weeks ago the financial and economic world declared itself staggered to learn that the 2009 Greek fiscal deficit was going to come in at 12.7% (mind you, as the conservative Dutch newspaper NRC Handelsblad pointed out, there was plenty of evidence of what was coming available long before for those who really wanted to look into the matter). Well, now get ready to be staggered again, since according to a spate of articles that have started appearing in the Greek press, the number which only so very recently had us all reeling in shock may be on its way up again, if only by "a few tenths of a percentage point". How many "tenths of a percentage point?" Well at this stage this isn't exactly clear. On 28 December the web portal Capital.gr reported (in Greek, but try Google translator):
“Temporary (cash) data from the flow of government revenues have fallen quite substantially when compared to those of the last quarter of 2008,... not only data for October-November, but the first indications for December show that the delay in the flow of public tax income (mainly) is important. The Treasury has also begun to "mumble" about the possibility that the deficit in 2009 is going "to close a few decimals above the anticipated 12.7 %...". How many decimals? This is unknown at present, although the General Accounting Office (YPOIK) displayed some optimism that the gap will not exceed 0.1% - 0.2% of GDP (ie the deficit will remain below 13%) even if some do not hesitate to speak of a deficit of over 13% of GDP.”

So it definitely looks like the deficit is likely to be signed off at something over 13%, but according to this article (Greek again, I'm afraid) from "Ta Nea online" on 2 January, speculation is still rife that the breach in the 13% mark could be substantial, and that the final figure may even be as high as 14.5%. If it fear was confirmed, it should not really catch is completely by surprise, since it could well be that now that spending is not accelerating as it was before revenue may be contracting very fast (for a simple illustration of how diminishing stimulus - let alone negative stimulus - works, see this post by Paul Krugman), and with both GDP and prices falling (systematic deflation), the deficit as a % of GDP can easily shoot up. Then again, there are reasons why it might be politically convenient to "book-in" a larger deficit in 2009, in order to make next years cuts look a lot bigger than they actually are (you start from a higher base), so who really knows. Will the true Greek 2009 fiscal deficit please stand up!

The more interesting dimension in the Ta Nea article is all the potential for intrigue it goes into. Evidently, nothing here is ever what it seems to be, and the article speculates that there are those in Pasok (the Greek socialist party) who are wheeling out and using the threat of declaring a 14.5% deficit as a bludgeon with which to try and moral-blackmail Brussels. The thinking seems to go that Brussels cannot afford to let Athens go to the wall at this point, so they would not want to see the kind of pandemonium which might break out if the markets cottoned on to a deficit of this magnitude. On the other hand key people in the governing party don't want to accept the kind of deep reforms the Commission is talking about in the Greek case, so they want to trade a smaller budget deficit for a bigger proportion of one-off measures. But then there are even more wheels within wheels, since it seems Brussels is adamant that it wants to present the reform package as a largely "made in Greece" affair, while those in Greece want to sell the package to their voters as being imposed by Brussels, so there are those who think the 14.5% deficit menace is being cooked up simply to make the Commission furious and get it to read the trems of the riot act out in public. Naturally, protagonists of this viewpoint should remember that old Greek saying, "whom the gods would destroy they first drive mad", so they need to be careful. And as the other old English saying goes, playing around with primed bombs is a decidedly dangerous thing to do. Definitely not recommened.

Structural Reforms AND Internal Devaluation

The Greek parliament passed a 2010 austerity budget just before Christmas aimed at reining in the country's soaring deficit by cutting public spending by 10 percent and cracking down on tax evasion. The budget is the government's response to growing pressure after the three main credit ratings agencies all downgraded Greece’s debt. Prime Minister Papandreou has vowed to bring the deficit to below 9.4 percent next year, but doubts remain as to whether the need for fundamental reform has been accepted, or whether Greek politicians are simply looking to apply some cosmetics and ride out the storm. In theory the 2010 budget aims to cut the 2009 deficit to 9.1% of GDP in 2010 through a combination of spending cuts (€8 billion are currently planned) ) and tax increases.

However, the budget has already been criticized by both the EU and the ratings agencies for relying too much on one-off measures, and too little on permanent reforms like cutting the public sector wage bill or stamping out widespread tax evasion. Moody's decision to cut its sovereign debt rating for Greece to A2 from A1 was widely interpreted as a mini victory for the Greek administration, but it could easily turn into a Pyrrhic one if the measures taken fail to convince. As Moody's stressed

"A further downgrade will depend on the Greek government's plan being followed through - as demonstrated, for instance, by a sustained increase in tax revenues and/or the effectiveness in reining in expenditure."

Finance Minister George Papaconstantinou stressed the government's commitment to far-reaching changes: "With this budget we begin our program of restructuring the economy...and cleaning up public finances," he said. But with Greece already under heightened EU budget supervision, what is needed at this point is something more than mere words, and the government will have to move quickly to convince both Europe's leaders and the financial markets that it is serious about reform.

A key moment is bound to come in mid-January when the government is due to present the EU Commission with its three-year stability and growth timetable outlining the government's medium-term plan to bring the deficit below an EU-mandated ceiling of 3% of GDP by 2013. The government has already pledged itself to introduce sweeping tax reform to boost government revenues, overhaul Greece's deficit-ridden pension system and outline plans for some €2.5 billion in privatizations, and it is presumeably the sum total of all these that is leading to those tensions in the governing party Pasok.

Aside from the fact that these measures are all very unpopular with the party's traditional electors, another problem arises. Most of the measures so far referred to are what could be referred to as "structural reforms", and these are very badly needed to lift Greece's long run growth rate slightly, and ensure fiscal sustainability in the face of a rapidly ageing population. But Greece has another problem - it's enormous current account deficit.

This deficit is largely a product of the large goods trade deficit, itself a reflection of the substantial loss of competitiveness that has characterised Greek industry during the years of the Euro-driven boom. Now the imbalances that this has all produced need to be corrected, and this correction needs to happen simultaneously with the fiscal correction. What this means is that in addition to the structural reforms Greece also needs to carry out what is known as an "internal devaluation", in order to make domestic industry more competitive in both the import and export sectors. And here comes the catch, since this devaluation will mean that GDP will fall even faster than otherwise, as prices also fall. Which means that the fiscal deficit will tend to be higher, and the debt to GDP level will rise even more rapidly than envisaged in the EU Commission forecasts - a process we have seen only to clearly in Latvia lately. And as many people continually point out, such processes are inherently difficult to carry through due to the political and social tensions they engender.

Just how serious this kind of problem this can become was highlighted in a Bloomberg article only today, where they point out that Japanese gross domestic product shrank to an annualized 471 trillion yen (or $5 trillion) in the third quarter of 2009. If you don't correct for changes in prices this takes Japan GDP back to levels not seen since 1991. As Paul Sheard, global chief economist at Nomura Securities International, points out, this tumble is unprecedented among developed economies since the 1930s. What's more, as a result of the ongoing economic contraction, the Finance Ministry now projects tax revenue in 2010 will drop to a quarter-century low.

More than a fifth of Japanese are over 65, according to the National Institute of Population and Social Security Research. The nation’s population began shrinking in 2006 from 127.8 million, and will drop by 3.2 percent in the coming decade, the Tokyo-based, state-sponsored institute estimates.

Japan faces the biggest fiscal gap among the Group of 20 advanced and emerging nations during the coming five years, according to a Nov. 3 report by the International Monetary Fund in Washington. Its deficit will remain as high as 8 percent of gross domestic product in 2014, compared with 6.7 percent in the U.S. and a balanced budget in Germany. Japan’s debt is projected to be 246 percent of GDP that year, compared with 108 percent for the U.S. and 89 percent for Germany, according to the IMF report.

Now Greece can't have exactly the same problem as Japan for a number of reasons. In the first place Japan currently runs a massive current account surplus, while Greece has an equally huge deficit. Further, Greece has no equivalent of the Bank of Japan, since it has no direct channel of influence over the ECB in Frankfurt (which evidently is responsible to a whole group of countries). But even more to the point, as part of a currency union there is an obvious limit to the deflation process, as the fall in prices would eventually restore competitiveness with the other euro area countries (which is where the root of the problem lies). But in the meantime the level of debt to GDP could be lead to rise even more sharply than currently anticipated, and even if the ECB should prove willing to support such a high debt to GDP level, it would still pose serious taxation and growth issues for Greek society.

So the bottom line here is that nothing is going to be easy. Greece now has a hard road to travel, and will need all the institutional support she can muster. Which is why it is high time Greek political leaders realised that this time there really is nowhere to hide, and that all the old games and tricks simply won't work now. They are playing with the future of others, would that they were capable of realising this.