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Peter/Marko changes in GREEN
Title: Greece: A Looming Default?
Teaser: Debt-riddled Athens' downgraded credit rating will make for difficult
budget decisions at home, and could spell trouble for other eurozone countries in
similar financial straits.
Summary: Greece's credit rating was downgraded from A- to BBB+ by Fitch
Ratings on Dec. 8, due to concerns over the country's debt levels. A number of
other eurozone nations, however, are facing fiscal situations nearly as difficult as
Athens', and the European Union may decide to use Greece as an example to
other high-spending nations to cut their debt levels.
Analysis:
Financial rating agency Fitch Ratings downgraded Greece's long-term foreign
currency and local currency issuer credit ratings to BBB+ from A- on Dec. 8,
citing concerns about the country's rising budget deficit. This is the first time
since Greece joined the eurozone that it has been downgraded below an "A"
grade rating. Meanwhile, rating agency Standard & Poor's warned Dec. 7 that
Greek banks faced the highest long-term economic risks in Europe.
Economic problems in Greece are causing investors to worry that the entire
eurozone could become destabilized. Indeed, one day following the Greek cut,
Standard & Poor's cut Spain's debt outlook from AAA to AA+, and the growing
Greek budget deficit and total government debt will be a subject of discussion at
the European Central Bank's (ECB) Governing Council meeting on Dec. 17.
Faced with the possibility that it will be made an example of by the EU as a way
of sending a message to other big spenders in the EU like Ireland, Italy, Portugal
and Spain, Athens is staring at difficult budgetary cuts for 2010.
<H3>Roots of the Crisis</H3>
Greece is considered one of Europe's most notorious overspenders. Even prior
to the current crisis, it was fighting high budget deficits, primarily caused by high
social spending, a symptom of the country's <link nid="128731">ever-present
social tensions</link>. The government's liabilities on the pension system and
through ownership of unprofitable enterprises, such as Olympia Airways, have
been difficult to jettison due to the <link nid="145004">threat of unrest</link>,
which flares up whenever Athens tries to rein in spending. Health and social
services, which is broken down between welfare, pensions, employment
subsidies and health care, counted for 35.9 percent of budget expenditures (10.9
percent of GDP) in 2009. Meanwhile, the combined cost of servicing the public
debt and interest payments on the debt account for approximately 40 percent of
budget expenditures (17 percent of GDP). Because of the large public debt and
the increasing deficit, the government has often turned to such creative methods
as fudging statistical reporting to the EU to avoid disciplinary measures from
Brussels.
<media nid="150377" align="left"></media>
The ouster of center-right Prime Minister Costas Karamanlis by his leftist rivals,
the <link nid="146639">Panhellenic Socialist Movement</link> (PASOK) in early
October continues the cycle of wild swings in Greek politics. PASOK has pledged
to not cut any social spending for the poor and instead increase taxes on the rich,
as well as crack down on tax evasion (a notorious problem in Greece) to reduce
the budget deficit. The government is also counting on a 9 percent increase in
total revenues in 2010, which may be optimistic considering a forecast GDP
decline for 2010. However, PASOK politicians are already admitting that they will
have to do whatever is necessary to cut the ballooning deficit (projected to reach
12.4 percent of GDP in 2009) and government debt (projected to hit 112.6
percent of GDP) , in part because the pressure from the EU on them is
enormous.
<media nid="150376" align="right"></media>
<H3>Greek Banking Troubles</H3>
In the background of the country's perennial spending problems are the troubled
Greek banks. STRATFOR <link nid="125633">cautioned about the Greek
banking system</link> at the onset of the current global financial crisis. As the
Baltic states and ex-communist Central European states entered the European
Union, Austrian, Italian and Swedish banks looked for new markets where they
would have an advantage over their larger German, French, British and Swiss
counterparts. They found that advantage in their former geopolitical spheres of
influence, with the Austrians and Italians entering the Balkans and Central
Europe, and the Swedes entering the Baltics.
European banks <link nid="125405">offered foreign-denominated currency
loans</link> -- mainly in euros and Swiss francs -- that carried with them lower
interest rate than domestic currency loans. Because they were the latecomers to
this game, Greek banks had to be particularly aggressive, using ever-lower
interest rates to attract clients and undercut the more resource-rich Italian and
Austrian lenders. Greek banks also had to rely much more heavily on foreigndenominated currency loans because their domestic deposits were much smaller
than those of Austrian and Italian banks (a strategy similar to the disastrous
banking methodology employed by <link nid="124926">Icelandic banks</link>.
Greek exposure, particularly to the Balkans, is therefore troubling for the overall
economy. The fear is that, unlike Italian and Austrian banks, Greek banks will not
be able to refinance loans or absorb losses of affiliates abroad. Greek banks
have thus far drawn around 40 billion euros of cheap credit from the ECB, out of
a total of around 665 billion extended to all eurozone banks. This represents
between 6 and 7 percent of total ECB outstanding liquidity, much higher than the
Greek share of EU economy (2.5 percent), and puts Greek banks second to only
the Irish in terms of dependence on ECB emergency liquidity.
<H3>The Road Ahead</H3>
The road ahead is not going to be easy for Greece. The ballooning government
debt is forecast by the European Commission to rise to 135.4 percent of GDP by
the end of 2011. Of the 39.9 percent increase in government's debt-to-GDP ratio
from 2007 to 2011, the European Commission estimates that 24.2 percent will be
attributed to interest expenditures. Furthermore, Athens will have to attract
investors for its government bonds by offering higher payouts. This is already
becoming evident as yield spreads between Greek and German bonds
(considered the safest government debt in the eurozone) have widened to 246
basis points on Dec. 9 (from 75 basis points in September 2008 before the
current economic crisis struck). These are the highest in the euro region by
almost 100 basis points, the second highest being Ireland's spread at 153 points
(which similarly rose from 48 basis points in mid-September 2008).
If Athens' route to international investors is barred by high prices, its only
remaining option would be to turn to the International Monetary Fund (IMF) or the
ECB for help. Thus far, the government has been resistant to an IMF loan
because of the enormous spending cuts in social programs it would necessitate.
Meanwhile, the problem with borrowing from the ECB is that EU rules prevent the
ECB from directly purchasing government bonds from EU member states. These
rules were designed by Germany precisely so member states could not expect
the ECB to print cash to rescue them from financial crises.
There is some wiggle room in ECB's rules. It can, for example, extend loans to
banks which use government bonds as collateral. This not only gives domestic
banks more liquidity to use on the domestic market, but it also increases demand
for Greek sovereign bonds, which is crucial in keeping their cost down. The ECB
has lowered the acceptable government bond rating as collateral to BBB- until
the end of 2010, which means that unless Greek government debt falls below the
investment grade category, the banks will at least have access to liquidity.
Ultimately, the key question for Greece is whether the EU will come to Greece's
rescue if raising funds on the international market becomes impossible. The EU
could force Greece to go to the IMF, or it could combine with the IMF (<link
nid="125435">as it did with Hungary</link>) to help Athens. At stake for the
eurozone is the potential cascading effect of a Greek default, which could impact
the other big spenders in the EU, primarily Ireland, but also Spain and Italy.
From EU's perspective, a Greek default would affect the rest of Europe by
essentially causing the cost of borrowing for eurozone member states -especially those in similarly egregious financial situation as Greece -- to rise. As
investors balk at the Greek default, similarly indebted Ireland, Spain, Portugal
and Italy would fall under scrutiny first, with potentially France following
quickly behind. Bond spreads would rise, indicating rising costs of debt, while
insurance against default would increase exponentially across the eurozone, with
probably only Germany unaffected by the increase. One immediate symptom of
investors losing confidence will be failing bond auctions, such as the <link
nid="139406">one Latvia experienced in Jun</link>e. And the problem will not
be confined solely to raising new debt, it will also seriously limit efforts by
countries to refinance their mounting debt.
<media nid="150375" align="left"></media>
But the EU also has to worry about sending the wrong message to other member
states as well. If Greece is bailed out, then what kind of a lesson is Brussels (and
essentially Berlin) teaching fiscally imprudent member states? Germany has
therefore sent mixed signals thus far on whether it would come to Athens’
aid. Statements from the German central bank, the Bundesbank, have thus
far been noncommitant, while German Chancellor Angela Merkel said on
Dec. 10 that the eurozone would stand in solidarity with Greece, but did not
specifically speak of a bailout. This is why statements from the German central
bank, the Bundesbank, thus far indicate that Greece will not be bailed out by the
EU and that the eurozone can more than survive a Greek sovereign debt default.
This could be a bluff, to force the Greek government to stick to budget cuts it
unveiled on Dec. 9 and thus follow in the footsteps of Ireland which is set to cut
the budget deficit by 4 billion euros, including salary cuts for more than 250,000
public sector employees. Insensitivity to Greek problems may also be the result
of center-right dominated EU (only Spain, Portugal and Greece are led by centerleft governments in the EU) forcing a socialist-led Athens to get serious about
economic reforms. The thinking in the EU (and the German-dominated ECB)
may be that it is better to make an example of Athens now, than have to deal
with Rome, Dublin, Lisbon or Madrid later.
The pressure is therefore going to be on Greece to cut spending and cut it fast.
The question is how the left wing government of new Prime Minister George
Papandreou will handle the inevitable social pressures that will accompany any
attempts at budgetary cuts, especially ones being dictated by Berlin. His
predecessor Karamanlis faced these same pressures during the December 2008
rioting, and ultimately buckled under the pressure. The one year anniversary of
the December 2008 rioting was marked by unrest in Athens, foreshadowing the
potential for more social angst in Greece in 2010.