COMMENCEMENT TIME FOR THE GREEK ECONOMY

Gikas A. Hardouvelis

Professor, Department of Finance, Un. of Piraeus Chief Economist & Director o Research, Eurobank EFG

September 24, 2010 Conference on Household Finance Athens, Greece 

CONTENTS
I. II. III. IV. Greece: The past & the future in concrete numbers Why does the market discount default with high probability? Can Greece get back to high & sustainable equilibrium growth rates? Summary: Commencement time for Greece

Gikas A. Hardouvelis

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I.
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Real Growth Rates in Greece were higher than in EU-15 from 1996 through 2009
4.5 5.9 4.2 3.4 1.9 1.2 2.3 4.6 4.5 4.5 3.6 3.4 3.4 2.7

%
2.9

5

Relative Living Standards ΕΕ-15=100 in PPS

3

3.1 1.2

2.8 2.5 2.4

3.9 3.0 3.0

1

-1

1.8 0.7 0.0

2.0 2.1 1.7 -0.3

2.2 3.0 2.6 2.0 1.8 1.2 0,5

1991 76.5 2009 87.4

-1.6
-3

Source: EU

-2.0 -4.2

-5

Greece: From boom to bust How come? Answer: Not an equilibrium growth

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

EU-15

Greece

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I.

Lack of competitiveness, which showed up in current account and in inflation differential
5 % 4 3 2 1

0 -2 -4 -6 -8 -10 -12 -14 -16

Current Account Balance
-2.8 -3.9 -5.6

Inflation
3.7 3.9 3.4 4.2 3.0 3.5 3.3 3.0 3.3 2.2 2.2 2.1 2.2 2.4 2.3 2.1 2.2 1.2 0.3
2009
4

Source: Bank of Greece
-6.8 -7.3 -6.5 -5.8 -7.3 -11.3 -11.1

2.9 2.1

-7.8

% GDP
1997 1998 1999 2000 2001 2002 2003 2004

-14.4 2005 2006 2007

-14.6 2008 2009

1.2
1999 2000

0

Source: European Commission
2001 2002 2003 2004 2005 2006 2007 2008

Current Account (€ mil) Goods Services Income Current Transfers
Gikas A. Hardouvelis

-26,630.9 -30,760.3 12,640.2 -9,803.5 1,292.6

Greece

Euro Area

2009 

I.
55% 50 45 40 35 30 25

Almost always in fiscal trouble, but fiscal mess grew prior to the onset of the 2009 recession

GDP
46.4 45.7

Greece
50.5 46.8 48.4 48.4 46.6 45.3 44.7

Average Expenditures 1990 - 2007: 44.6%
44.8 44.9 44.4

43.7 44.7 45.0 45.5 44.1 44.6 44.1 44.3 43.0 42.9 40.3 39.0 41.3 39.7 40.5 41.7 40.9 38.0 40.5 39.1 39.7 39.0 39.2 39.0 38.5 36.3 36.9 38.5 37.4 36.7 34.5 31.8 33.2 Huge expansion in expenses already in 2008 EU 28.9 forecasts 30.8 In 2008, Greek real growth was 2% 28.4

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Revenues
Gikas A. Hardouvelis

Expenditures
5

Source: European Commission, Spring 2010 forecasts 

I.

The Revised EU/IMF/ECB adjustment program
Assumptions
2009 2010 -4.0 3.5 236 4.9 225 2011 -2.6 1.3 233 4.9 275 2012 1.1 0.4 236 5.3 350 2013 2.1 0.7 243 5.6 350 2014 2.1 1.0 251 5.8 350 2015 2.7 1.1 260 5.8 350 2020 3.3 1.6 329 5.9 350

GDP Growth (%) GDP deflator (%) Nom. GDP (€ bn) Int. Rate (%) Bund Rate

-2.0 1.4 237 5.0

Sensitivity analysis
Debt-to-GDP Baseline Higher growth +1% per year Lower growth -1% per year 2009 115 115 115 2010 130 129 132 2011 139 135 144 2012 144 137 151 2013 144 134 155 2014 140 126 154 2015 134 118 152 2020 111 74 154

Source: Revised EU/IMF/ECB adjustment programme

In the optimistic scenario, debt/GDP will be in 2020 where Spain is today
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Ι. The Revised EU/IMF/ECB program: Detailed forecasts
2009 Current Account (%GDP) Gen Gov Deficit (%GDP) (€ bn) Gen Gov Debt (%GDP) (€ bn) Interest Expense (%GDP) (€ bn) Primary Surplus (%GDP) (€ bn) -11.2 -13.6 -32.3 115.2 273.5 5.0 11.9 -8.6 -20.4 2010 -10.8 -7.9 -18.6 130.3 307.5 5.6 13.3 -2.2 -5.3 2011 -7.8 -7.3 -17.0 139.4 324.6 6.5 15.2 -0.8 -1.8 2012 -6.9 -6.2 -14.7 143.6 339.4 7.2 17.1 1.0 2.4 2013 -6.0 -4.7 -11.5 144.0 350.0 7.8 18.9 3.0 7.4 2014 -5.1 -2.5 -6.2 139.5 349.5 8.1 20.4 5.7 14.2 2015 -4.0 -2.0 -5.1 134.0 348.7 7.8 20.3 5.9 15.2 2020 ------111 365.1 ----6.0 19.7

Source: EU/IMF/ECB adjustment programme

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II. Material risks exist but can be contained
a) Will the recession end soon? As European belt-tightening is currently taking place, low European growth may cause Greek economic growth to stall. EU funds are not sufficiently mobilized yet, while privatizations have taken the back seat. Drastic initiatives on growth required. Yet, Greece is a relatively closed economy and over half of its exports are channeled outside the Euro Area. In addition, core EU still growing. Once sentiment stabilizes, private investment may stop declining, giving a boost to domestic output Risks of the Gargantuan task of grabbing tax evasion without instituting moral hazard through frequent tax amnesties Yet, a switch to a stable and transparent tax regime requires time to implement and in the meantime revenue collection expected to suffer Risk of silent anger from the population of wage earners in H1 2011 with the rise in unemployment and decline in incomes and if government fails to address the rampant tax evasion High bond risk premia may persist, which could prohibit Greece from tapping the bond market in two years or so Yet, if program is successful risk premia ought to decline, while a lengthening of the maturity of the EMU €110 bn loan is likely Collapse of the financial system: Is it probable? No, as long as ECB provides liquidity and no population panic takes place.
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b)

c)

d)

e)

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II.

The market is extremely negative and oblivious to the change in risk sources
1100 1000 900 800 700 600 500 400 300 200 100
2/11/2009 13/11/2009 24/11/2009 5/12/2009 16/12/2009 27/12/2009 7/1/2010 18/1/2010 29/1/2010 9/2/2010 20/2/2010 3/3/2010 14/3/2010 25/3/2010 5/4/2010 16/4/2010 27/4/2010 8/5/2010 19/5/2010 30/5/2010 10/6/2010 21/6/2010 2/7/2010 13/7/2010 24/7/2010 4/8/2010 15/8/2010 26/8/2010 6/9/2010 17/9/2010

A nervous market
On September 5-yr CDS was 885.5 bps implying a cumulative risk-neutral probability of 34.3% for a total capital loss any time during the 5-year period, or a 99.9% probability for a capital loss of 10% Even more worrisome is the following: On September 21st the 2-year Greek Government bond yield was 9.3%, a spread of 851 bps over Bunds!! 17th,

bp

5-year CDS rates Greece & Ireland

Source: Bloomberg

Greece

Ireland

Yet Greece does not need to go the market to get financed for 2.5 years! Illiquidity? Overreaction? The market seems to believe that: Either the Greeks are incapable of absorbing the €110 bn rescue funds Or the EMU members will not be able to deliver the funds
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II. Once primary balance is attained it makes no sense to default
Markets appear oblivious to this regularity
Cottarelli et.al: Countries are forced to default, they do not choose it Once advanced countries bring primary deficit to zero, they continue fiscal tightening After sovereign bond spreads rose above 1000, no credit event in 80% of cases In the case of Greece, default would not solve its fiscal problem
Gikas A. Hardouvelis

Cottarelli et.al. (2010), IMF

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II. Yet, should Greece default if program were to succeed?
The argument goes that if the EU/IMF/ECB Program succeeds and in 2012-2013 Greece begins generating the first primary surpluses, then it would be tempted to restructure its huge debt. However, this event cannot happen because: 1. A Greek default would be an EMU decision, not a Greek decision. Stakeholders of GGBs are primarily Greeks and other EMU members. They do not want a default. i. Greek banks own approximately €45 bn, pension and other funds another €25bn, individuals around €15bn. Thus, a haircut would force the government to bail out its banking sector and its pension system ii. EMU banks hold a major chunk of GGBs, most of it posted at the ECB as collateral. EMU members would object to a default. It may create FI bankruptcies in EA-16. iii. The ECB holds significant amounts of GGBs both directly (~ €23 bn) and in the form of collateral. Greece cannot go against its own lender of last resort iv. EMU countries have given €80 bn in loans (& IMF €30 bn), on which Greece cannot default 2. Risks of contagion in the European financial sector with a possible spread of fear for EMU sustainability 3. Huge adjustment costs for Greek borrowing during the default/restructuring process and inability to tap the markets for a long time 4. Interest costs will increase for the Greek private sector as well, reducing growth
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III. Can Greece resume its past high growth rates?
1) Reforms are drastic & on time, particularly the pension, labor and fiscal ones - Strong inertia for reforms - Government ahead of the curve Unusually benevolent political environment An end of the recession by sometime in H2 2011 is within reach, yet more drastic action is needed In the intermediate-run, growth can come back - making the level of debt less onerous i. ii. A strong private sector, which is under-levered with rich citizens, plus a conservative banking sector There is a strong growth potential in Greece, especially if competitiveness is restored
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2) 3) 4)

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130%

180%

230%

280%

330%

380%

30%
E A -1 6

% of 2010 1GDP
20 34 29 21 20 17 17 8, 9 0, 5, 1 8, 1 2, 9 5, 7 ,3

80%

Gikas A. Hardouvelis

L u x /b u rg C y p ru s D e n m a rk Ire la n d S p a in P o rtu g a l N e th e rla n d s M a lta S weden A u s tria L a tv ia Ita ly G re e c e E s to n ia G e rm a n y F ra n c e S lo v e n ia F in la n d B e lg iu m B u lg a ria L ith u a n ia H u n g a ry C ze c h P o la n d S lo v a k ia R o m a n ia

13 11 10 5, 7, 0

16 2 8, 16 2 3, 8 7

III. Greek private sector is rich and under-levered

Private Loans / GDP

Loans to non MFIs excl. Gen. Government from MFIs excl. Eurosystem, June 2010, % of 2010 GDP (EU forecasts)

51 46 46 38
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8, 10 4 7, 10 5 6, 10 3 5, 10 1 4, 10 0 1, 8 92 ,4 92 ,0 86 ,3 75 ,7 68 ,6 63 ,6 ,1 ,9 ,4 ,4

Greeks own a large fraction of international shipping Greek bank deposits are 1.1 times GDP Private leverage low 

III.

A solid banking sector: Greek banks prudent and strongly capitalized
1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 -0.2

Greek banks did not cause the recession in the country like it occurred in the US or in Western Europe The banking system is deposit rich (L/D 118% for banking groups); ECB offers strong support, while contingent liquidity (now over 20% of deposits) will be further boosted (covered bonds, government’s liquidity scheme, limited refinancing needs) Greek banks strongly capitalized (CAD ratio at 11.7%, Tier I at 11.0%)

Return On Assets
EU-27 Greece

Source: ECB, BoG

2007

2008

Asset quality worries seem overblown (NPLs at 8.2% in 2010-Q1, experience of two crisis years, NE countries); Greek private sector is not over-leveraged; Pre-provision margins 40% wider than EU; absence of toxic assets and no real estate bubble Substantial CEE/SEE exposure offsets Greek strain; profits to track economic recovery in the region Greek banks have annual net revenue buffers in excess of € 3.5bn, including: 2010 profitability run-rate, further re-pricing in Greek loan segments, streamlining of operations and cost containment as well as synergies from potential sector consolidation
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III. Strong growth can resume in the future
High productivity growth can continue in the future, once the recession is over, for a number of reasons: Capital intensity lower than EU average, infrastructure projects needed, funding is available Real wages are declining by over 10%, improving competitiveness, which did not deteriorate a lot in the serves sector
200

Capital Intensity

Public sector crowding in, Structural reforms & building of social institutions will result in a more export-oriented and competitive economy, with gains estimated by some researchers at around 20% of GDP Capturing the underground economy, which is close to 25-30% of GDP, will improve all debt magnitudes. EUROSTAT revisions expected soon.
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180

160

Growth in Unit Labor Costs relative to trading partners

140

120

100

80 2000 2001 2002 2003 2004 2005 2006 2007 2008
Industry Agriculture Services

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IV. Summary: Commencement time for Greece
Despite significant risks, the EU/IMF/ECB Program has a high chance to succeed as fiscal consolidation proceeds as planned, drastic structural reforms are ahead of the EU/IMF/ECB conditionality dates, the public is not responding negatively to belttightening and the governing center-left political party has strong parliamentary majority and can stay in office for additional 3 full years. Markets presently discount a significant haircut in Greek government bonds. Yet, once primary surpluses become feasible in 2012-13, debt restructuring would not be optimal as the stakeholders are Greek or other EMU members. The recession is expected to be over by 2011 H2, once investment spending stabilizes and the net export sector improves its share in domestic value added. Long-term growth can gradually recover: From expected further productivity gains coming through faster capital accumulation, lower real wages, public sector crowding in, product market reforms plus a gradual capturing of the underground economy The strength of the under-levered and wealthy private sector and the strength of the banking sector The current account imbalance and competitiveness can improve thanks to on going product and labor market reforms and the re-organization of the public sector This is commencement time for the Greek economy, to be built on consensus
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THANK YOU FOR YOUR ATTENTION !

ghardouvelis@eurobank.gr +30-210-333-7365 www,hardouvelis.gr

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