Sunday, May 2, 2010

An Omen of Things to Come?

Dan Bilefsky and Landon Thomas Jr. of the NYT report, Greece Agrees to a Bailout Deal With EU and I.M.F.:
ATHENS — Prime Minister George Papandreou said Sunday that Greece had reached an agreement with the International Monetary Fund and the European Union on a long-delayed rescue package that is expected to be worth as much as €120 billion. The deal aims to help the country avoid debt default and prevent economic contagion from spreading throughout the region.

In a televised statement to the nation, Mr. Papandreou urged Greeks to accept “great sacrifices” to avoid “catastrophe.”

“I have done and will do everything not to let the country go bankrupt,” he said, appearing sober and resolved in front of his cabinet and appealing to Greeks to show patriotism at a moment of deep crisis. “I want to tell Greeks very honestly that we have a big trial ahead of us.”

He signaled that public-sector employees would see their salaries further reduced, while pensions for retired civil servants would be scaled back. He said members of Parliament would do without their bonuses. He added that in tough negotiations with the International Monetary Fund, the European Union and the European Central Bank, the government had succeeded in avoiding cuts to private-sector salaries.

Mr. Papandreou is the scion of a Socialist dynasty whose father, Andreas Papandreou, helped erect the sprawling Greek welfare state when he was prime minister in the 1980s. The younger Papandreou sought to embolden Greeks to accept what is expected to constitute the greatest overhaul of the state in a generation.

The unprecedented $160 billion bailout of a member of the 16-nation euro zone is the culmination of months of often fraught negotiations. The crisis has tested the credibility of the single currency and created some of the deepest fissures in the European project since its inception, more than half a century ago.

Finance Minister George Papaconstantinou set out some of the details of the austerity measures that are required for the bailout package, which were expected to be disclosed in Brussels later Sunday.

He said that Greece would make budget cuts of €30 billion, or $40 billion, to reduce the budget deficit to less than 3 percent by 2014.

He said the funding from the rescue plan would cover a large part of Greek borrowing needs for the next three years. The country faced a “choice between collapse or salvation,” he said.

Mr. Papaconstantinou, who was to fly to Brussels for an emergency meeting of euro zone finance ministers, said Greece had agreed to raise its value-added tax to 23 percent from 21 percent, to cut civil servants’ wages and to eliminate public-sector annual bonuses amounting to two months’ pay.

He said special rules allowing for early retirement of civil servants would be tightened. He said the government also intended to increase taxes on fuel, tobacco and alcohol by about 10 percent.

Crucially, Mr. Papaconstantinou did not address the critical issue of whether the government would relax rules on laying off public workers, whose generous salaries and benefits have been a major cause of Greek’s debt problem. Until now, the government has not been able to lay off civil servants, whose employment rights are in effect constitutionally guaranteed.

Indicating that the steps would undermine economic growth, Mr. Papaconstantinou forecast a deeper than expected recession of 4 percent for 2010 and 2.6 percent in 2011 before a return to growth of 1.1 percent in 2012.

“We will be in recession for the next few years, which means that we have to run faster to reduce the deficit,” he said.

The government will submit special emergency legislation to Parliament, which is expected to approve the measures by Friday.

After months in which Germany balked at the prospect of bailing out the euro zone’s most profligate members, European leaders have in recent days been racing to hammer out the package for Greece with new urgency after ratings agencies downgraded Greece’s debt ratings to junk status.

The bailout amounts to €45 billion this year, followed by more aid in the following two years.

In return, Greece pledged to squeeze cost savings and tax increases amounting to an estimated €24 billion, or 10 percent of the country’s gross domestic product. The measures include €4.8 billion in belt-tightening steps announced in March.

While the economic lifeline for Greece is expected to reassure jittery markets, doubts remain whether Greece will be able to follow through on what amounts to a cultural revolution in the social contract between state and citizen.

The shakeup of longstanding aspects of Greek life, from endemic tax evasion to overstaffed offices of idle employees, has prompted fears that widespread social unrest could unhinge a Greek recovery.

And while most economists agree that the austerity measures are long overdue, some fear that if they push Greece into an even deeper recession, the political will to follow through on the changes will be undermined.

The governing Socialist party of Mr. Papandreou has 160 seats in the 300-seat Parliament, giving it enough of a majority to implement laws. Mr. Papandreou in recent days has likened Greece’s plight to Odysseus, Homer’s heroic survivor who took 10 years to return home from war. He has thus far largely escaped blame for a crisis that has been pinned on the profligacy of his predecessors. But analysts warn he could face a fierce backlash if the austerity measures do not deliver visible economic gains soon.

The government’s proposals for deep spending cuts already have stoked strong resentments in a country where one in three people is employed in a civil service that, until now, has guaranteed jobs for life.

In a sign of the challenges ahead, tens of thousands of Greeks took to the streets across the country Saturday. Some in Athens chanted, “No to the I.M.F. junta!” — a reference that conflated the International Monetary Fund and the hated military regime that ruled Greece from 1967 to 1974.

Some analysts feared that the Saturday demonstrations, in which dozens of black-clad anarchists threw Molotov cocktails and stones at the police, might prove to be the beginning of protracted social unrest. Unions are planning mass demonstrations for Wednesday.

The protests have thus far been largely peaceful and muted, suggesting that most Greeks realize they have few options other than to endure and wait.

Over the past few days, Greeks have reacted with anger and wounded pride as their country has been derided as the economic sick man of Europe.

Alluding to the film “Apocalypse Now,” the cover of The Economist this week showed a picture of the Acropolis under the headline “Acropolis now,” with I.M.F. and European Union helicopters hovering above and a picture of the German chancellor, Angela Merkel, decked out in military fatigues. “The horror, the horror,” it continued.

Yannos Papantoniou, a former finance minister from the Socialist party, said Greek patience with the cost-cutting measures could run out, in particular, if the large population of poor Greeks were hit hard, if recession did not give way to growth and if already high unemployment increased.

“My impression, having managed this type of situation in the 1990s, is that Greeks are not patient people,” he said in an interview.

“For Greeks to endure cuts for the next three years, they must be shown results and be convinced that the government is hitting its targets. It is essential that the government follow pro-growth policies to avoid a deep depression.”

Yet economists warn it could take years for the cost-cutting measures to lift incomes. According to a report to appear Monday in the German magazine Der Spiegel, the I.MF. believes it will take 10 years for Greece to overcome its financial crisis, Reuters reported.

And while economists say the bailout package will reassure markets in the short term, some fear that a credit crunch could persist, undermining already depressed consumer spending and depriving businesses of much-needed funding. That threat was underlined Friday when Moody’s Investors Service cut the credit ratings of nine Greek banks.

Platon Monokroussos, head of financial markets research at Eurobank EFG, one of the biggest banks in Greece, predicted that the austerity measures would keep the country in recession until at least late 2011. He forecast at least two years in which the economy would contract by 3 percent or more before the measures in the austerity package provided a lift.

While E.U. and Greek leaders have insisted that Greek debt restructuring is not an option, some economists argued that a debt restructuring, in which private creditors would take a hit by not receiving back all of their money in the agreed time, should not be written off as an option in the future.

It would reduce the overall debt burden on Greece’s economy but would also create the heavy risk of pushing spooked investors to deny Greece access to credit markets.

If Greece fails to implement its cost-cutting measures and European governments and the public grow wary of propping up the country, some economists predict that the possibility of a restructuring could once again emerge. But Yiannis Stournaras, a leading economist and former economic adviser to the ruling Socialist party, argued that the close monitoring by the I.M.F. — and intense scrutiny by the E.U. — would prevent the Greek government from deviating from the path of reform. A restructuring, he argued, would “return the country to an economic ice age.” “The I.M.F. will be here every few months and will be keeping a close eye on Greece’s every move,” he said. Alluding to a mythological battle in which Greek soldiers attacked the enemy after hiding in a giant hollow wooden horse, he added: “People haven’t trusted the Greeks since the time of the Trojan War so this is nothing new.”

Greece will bite the IMF bullet and go through another major recession, one that will bring about more social upheaval with the end result being far from clear.

German Chancellor Angela Merkel, not missing an opportunity to score political points at home, said she was right to demand International Monetary Fund involvement in the Greek bailout over the objections of her European peers, saying it resulted in previously “unthinkable” budget cuts by Greece.

It remains to be seen how successful the Greek government is in implementing these austerity measures. There is a deep distrust in Greece over government as many believe political corruption has fueled the debt crisis. I suspect that Greeks will accept some changes, but many will continue to protest, mostly in vain.

Writing for the FT, GMO's Edward Chancellor warns, Greece a bad omen for others in debt:

The single most important indicator of credit weakness is the national savings rate. Greeks are among the world’s leading spendthrifts with a net savings rate of around -7 per cent of GDP, according to Tim Lee of Pi Economics. Japan, by contrast, has been able to finance the huge expansion of its national debt over the past two decades thanks to its traditionally high savings rate. However, as its population ages, Japanese household savings are set to turn negative. Both the US and UK also have negative net savings rates.

Countries with low savings tend to grow more slowly and depend on external sources to fund fiscal deficits. In good times, governments have little trouble finding the money. Yet foreign creditors are more skittish than domestic ones; they take fright easily and during times of contagion are liable to force up interest rates, creating a debt spiral. This is what is happening to Greece where roughly 70 per cent of the national debt is held by foreigners.

The stock of outstanding government debt relative to GDP is another important measure of sovereign credit standing. Research by economists Carmen Reinhart and Ken Rogoff suggests that when the government debt burden becomes larger than 90 per cent of GDP, economic growth tends to slow, reducing the tax revenues needed to repay the loans. Greece’s government debt to GDP ratio is forecast to reach a 135 per cent by 2011. Yet it is not the worst culprit. Japan’s government debt is set to climb to 227 per cent of GDP by the end of next year.

The national debts of Britain and the US are also forecast to exceed the 90 per cent of GDP threshold by 2011. With their low domestic savings rates, the US and Britain depend on external financing. If foreigners were to lose confidence in either US or UK government finances, they would also demand higher interest rates.

The IMF has calculated the level of fiscal frugality needed for countries to bring their government debt levels down to a sustainable 60 per cent of GDP. According to the Fund’s calculation, the US would have to run a budget surplus prior to financing charges of 4.5 per cent of GDP a year for 15 consecutive years to bring the national debt down to an appropriate level. Japan would have to run a fiscal surplus of some 15 per cent of GDP for 15 years to reach the same target.

Rapid growth in government indebtedness is a further indicator of sovereign vulnerability. Mr Reinhart and Mr Rogoff observe that sovereign defaults normally occur after a frenzied run-up in debt. The average increase in debt in the four years prior to a sovereign default has been 40 per cent. By coincidence, Greek debt is forecast to rise by exactly this amount between 2007 and 2011. The national debts of the UK and Japan will climb by 44 per cent over the same period.

Quantitative indicators of sovereign credit vulnerability do not tell the whole story. Countries with bloated government sectors and cultures of entitlement, such as Greece, are more likely to default. There is an alternative. History suggests that when governments raise taxes and cut spending they are less likely to default.

Most governments, however, will follow the path of least political resistance. This will mean more spending and continuing fiscal deficits. Mr Reinhart and Mr Rogoff find that the cycle of sovereign defaults tends to pick up a few years after banking crises. Given the severity of the global credit crunch and the weak state of government finances in most advanced economies, it is unlikely that future sovereign debt crises will be confined to the shores of the Mediterranean.

Finally, take the time to watch the RT report below. It's sad to see a whole generation of Greeks will end up paying a heavy price for things that were out of their control. And it's not just Greeks that will end up paying a heavy price. The effects of the 2008 credit crisis will linger with us for decades, wiping out a generation of hopes and dreams.

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