ECoNoMiC bARoMETER

GrEEcE’s marriaGE oF nEcEssity to tHE EurozonEEuropean political and financial leaders met recently to thrash out a second bailout agreement for the belueagured Greek economy, which has been floundering for some time now, threatening to sink much if not all of the eurozone – and potentially the world’s economy – with it. Karim Nakhle looks at the pros and cons of the latest Greek bailout agreement, and if this deal is really for better or worse.

Watching the Greek bailout meetings of leaders in the European Union (EU), the viewer can be transcended, just

like in the movie My Big Fat Greek Wedding, down memory lane into just the magical moments: the first kiss (in Greece’s case, the first default), and the first side by side picture of the bride and groom (recall the picture of the EU leaders during the first bailout). This is shortly followed by pre-recorded testimonials

from the best friends – here it is the new ‘Troika’ of the European Central Bank (ECB), The International Monetary Fund (IMF) and the EU, wishing the bride and groom a great future, financial health and prosperity.

Similarly to a Greek wedding reception, at the Greek bailout party, the guests – most prominent among them Angela Merkel, German Chancellor, Mario Draghi, president of the ECB, Christine Lagarde, head of the IMF and Jean-Claude Juncker, Luxembourg president and head of the euro group of

finance ministers, are on their best behaviour, laughing and cheering on, as Greece gets another round of easy money.

Indeed, the second bailout for Greece finally became a reality on March 14 when the eurozone nations formally approved the plan, tying yet another knot with the Greek government, administered by the Troika, which authorised the release of the first multibillion-euro loan instalment.

But let us stroll down memory lane and remember what led to this sacred union

For BETTEr or For WorsE

ECoNoMiC bARoMETER

TheEDGE 49

As the world economy cooled in the late 2000s, Greece was hit especially hard, because its main industries — shipping and tourism – were highly fragile.

European Commission representative and head of the Greek ‘Troika’ bailout mission, Matthias Mors, talks on March 16, 2012 during the presentation of the Troika’s Second Compliance Report for Greece at the EU headquarters in Brussels. (Image Corbis)

between the eurozone countries. From late 2009, fears of a sovereign debt crisis developed among investors as a result of the rising government debt levels around the world, together with a wave of downgrading of government debt in some European states. Concerns intensified in early 2010 and thereafter, leading Europe’s finance ministers on 9 May 2010 to approve a rescue package worth EUR750 billion (QR3 trillion), aimed at ensuring financial stability across Europe by creating the European Financial Stability Facility (EFSF). To restore confidence in Europe, EU leaders also agreed to create a common fiscal union including the commitment of each participating country to introduce a balanced budget amendment.

How each European country involved in this crisis borrowed and invested the money varies. For example, Ireland’s banks lent the money to property developers, generating a massive property bubble. When the bubble burst, Ireland’s government and taxpayers assumed private debts. In Greece, the government increased its commitments to public workers in the form of extremely generous pay and pension benefits. Iceland’s banking system grew enormously, creating debts to global investors – so-called

“external debts” – several times gross domestic product (GDP).

The interconnection in the global financial system means that if one nation defaults on its sovereign debt or enters into recession, putting some of the external private debt at risk, the banking systems of creditor nations face losses. For example, in October 2011 Italian borrowers owed French banks US$366 billion net (QR1 trillion). Should Italy be unable to finance itself, the French banking system and economy could come under significant pressure, which in turn would affect France’s creditors and so on. This is referred to as financial contagion. Another factor contributing to interconnection is the concept of debt protection. Institutions entered into contracts

called credit default swaps (CDS) that result in payment should default occur on a particular debt instrument (including government issued bonds). But, since multiple CDSs can be purchased on the same security, it is unclear what exposure each country’s banking system now has to CDS.

greece’s fragile econoMyIn the early mid 2000s, Greece’s economy

was one of the fastest growing in the eurozone and the government took advantage of this by running a large structural deficit, partly due to high defence spending amid historic enmity to Turkey. But as the world economy cooled in the late 2000s, Greece was hit especially hard, because its main industries – shipping and tourism – were especially fragile and sensitive to changes in the business cycle. As a result, the country’s debt began to increase rapidly.

On 23 April 2010, the Greek government requested an initial loan of EUR45 billion (QR211 billion) from the EU and IMF, to cover its financial needs for the remaining part of 2010. A few days later Standard & Poor’s slashed Greece’s sovereign debt rating to BB+ or ‘junk’ status amid fears of default, in which case investors were liable to lose 30 to 50 percent of their money. Stock markets worldwide and the euro currency declined in response to this announcement. On 1 May 2010, the Greek government announced a series of austerity measures to secure a three-year EUR110 billion (QR517 billion) loan. The Troika (EU, ECB and IMF), offered Greece a second bailout loan worth EUR130 billion (QR611 billion) in October 2011, but with the activation being conditional on implementation of further austerity measures and a debt restructure agreement.

economy and allow for a trade-driven recovery. However with many of Greece’s trading partners also now plunging back into recession as a consequence of the flawed fiscal austerity being imposed upon them by the Troika, there would appear to be little hope of an export-led recovery. The IMF however always presents an optimistic projection to accompany their demands for austerity.

In reality, the latest EU bailout will not end the uncertainty, neither will it be the final bailout. Greece will not be able to withstand a decade of repressive economic policies. The reality is that this ‘deal’ only buys some more time. In the meantime, the real situation in Greece will continue to worsen. The new bailout would stave off bankruptcy, which was imminent in a formal sense, at the end of March 2012. After studying the full report issued following the meeting and thinking about the underlying economics of the situation, it does not take long to realise is that

TheEDGE50

ECoNoMiC bARoMETER

Demonstrators shout slogans during a protest against austerity measures, in front of Parliament in February in Athens, Greece. As finance ministers across the eurozone were calling for greater scrutiny and oversight of Greece’s proposed budget cuts in order to approve the latest EUR130 billion (QR611 million) bailout package. (image Getty Images)

In February 2012, an IMF official negotiating Greek austerity measures admitted that excessive spending cuts were harming Greece. Some economic experts argue that the best option for Greece and the rest of the EU, would be to engineer an “orderly default”, allowing Athens to withdraw simultaneously from the eurozone and reintroduce its national currency the drachma at a debased rate. However, if Greece were to leave the euro, the economic and political impact would be devastating. According to analyst an exit would lead to a 60 percent devaluation of the new drachma, hyperinflation, military coups and possible civil war that could afflict a departing country.

To prevent this from happening, the troika (EU, IMF and ECB) eventually agreed to provide a second bailout package worth EUR130 billion (QR611 billion), conditional on the implementation of another harsh austerity package (reducing the Greek spending with EUR3.3 billion (QR15 billion) in 2012 and another EUR10 billion (QR47 billion) in 2013 and 2014). For the first time, the bailout deal also included a debt restructure agreement with the private holders of Greek government bonds (banks, insurers and investment funds), to voluntarily accept a bond swap with a 53.5 percent nominal write-off, along with lower interest rates and the maturity prolonged to 11 to 30 years (depending on the previous maturity).

It is the world’s biggest debt restructuring deal ever, affecting some EUR206 billion (QR968 billion) of Greek government bonds. The debt write-off had a size of EUR107 billion (QR502 billion), and caused the Greek debt level to fall from roughly EUR350 billion (QR1 trillion) to EUR240 billion (QR1 trillion) in March 2012, with the predicted debt burden now showing a more sustainable size equal to 117 percent of GDP, somewhat lower than the originally expected 120.5 percent.

a recipe for success?Greece has been in a recession for five

consecutive years. The hope is that the so-called EUR130 billion (QR611 billion) bailout package (or potentially EUR173.6

billion (QR815 billion) as some estimate (see box out) will be enough to keep Greece funded until 2014-2015.

However, talk of a third Greek bailout has already started with the ink still wet on the second one, especially following a report by EU experts highlighting the risks to structural-reform implementation and predicting “at best stagnation” for 2013.

Furthermore, the austerity programmes set in place by the Troika on Greece are savaging other incomes that drive aggregate demand. Firms will not increase output when there is no sustainable growth in demand nor will they expand investment (to build more productive capacity), if the current stock of capital can adequately meet the current (declining) demand for goods and services.

The IMF hopes that the recovery will not come from domestic demand but rather that the lower unit labour costs will improve international competitiveness of the Greek

to B- from C rating. Fitch kept a C rating on foreign-law bonds as the settlement date for their swap is not until April 11.

The situation in the financial markets is slowly improving in response to the ECB’s measures, but also in response to the progress made by euro area governments. Nevertheless, we will not have an outburst of optimism for the time being, as this is a bit premature, especially since the eurozone’s recovery will be slower and harder than expected.

Meanwhile just like in all marriages, we wish the Greek bride and her European groom all the best, hoping that they live happily ever after.

the potential caveats that are involved with the deal make it a temporary solution that will hopefully ease some uncertainties for Greece, and the eurozone as a whole. Following approval of the second bailout package, credit agency Fitch has upgraded Greece’s new government bonds, from ‘Restructed Default’ to B-, which might signal that things seem to be looking up for the euro area.

Nevertheless the new B-rating, which applies to the new bonds issued under Greek law, is still junk status, meaning they are not investment grade despite the huge cut to Greece’s debt pile. Securities not eligible for the bond exchange were also upgraded

On 23 April 2010, the Greek government requested an initial loan of EUR45 billion (QR211 billion) from the EU and IMF.

Like all eurozone political and financial leaders, no doubt aware what serious repercussions a Greek default could have for the region and indeed world economy, German Chancellor Angela Merkel cast her ballot during a vote over a second EU-aid package for Greece in the Bundestag in February in Berlin, Germany. (Image Getty Images)

Parsing of details in the European Troika’s Second Compliance Report for Greece, seen on March 16, 2012 during the presentation of the at the EU headquarters in Brussels, Belgium, indicates that the total EU-IMF assistance covering Greek needs over the next five years may total EUR173.6 billion (QR815 billion) and not EUR130 billion (QR611 billion).

ECoNoMiC bARoMETER

TheEDGE 51

iS ThE lATEST GREEK bAiloUT REAllY WoRTh jUST EUR130 billioN?Things do not get easier in a wedding, and you always have to end up spending more than what you have hoped for…same goes for any bailout. According to a recent 190-page report by EU and IMF monitors, the current bailout is actually larger than the declared value. Here is our attempt to explain why the figures have gotten so confusing and the bailout is probably larger than the EUR130 billion (QR611 billion) anticipated…better described as a EUR164.5 billion (QR773 billion) rescue. Or maybe it is EUR173.6 billion (QR815 billion).The key thing to remember is that the first EUR110 billion (QR517 billion) Greek bailout was originally supposed to run through to the middle of next year and its remaining funding will be folded into the new package and added

to the EUR130 billion (QR611 billion) in new funding. According to the report, EUR73 billion (QR343 billion) of the first bailout has been disbursed, leaving about EUR37 billion (QR173 billion).Again, to complicate it even more, the IMF has changed its Greek programme from a ‘stand-by arrangement’ to an extended fund facility. The differences are rather esoteric, but the main consequence is that IMF loans will be distributed over five years instead of the previous three. So of the EUR28 billion (QR131 billion) in IMF money, only EUR19.8 billion (QR93 billion) will be used over the course of the new three-year programme.By that calculation, the new bailout will be EUR164.5 billion (QR773 billion). If you include payments stretching into 2016, however, the number gets bigger. Elsewhere in the report, it is quoted that the total EU-IMF assistance covering needs over the next five years totals EUR173.6 billion (QR815 billion).