By Dimitris Kontogiannis
The markets have placed their money on the Greek economy recovering from the protracted recession, pouring billions of euros into banks, other companies and the state. In so doing so, they have chosen to give limited significance to political risk. In about three weeks, their assumption will be put to the test as millions of Greeks cast their ballot to choose a representative for the European Parliament and indirectly determine the fate of the coalition government. It is difficult to gauge whether the markets are right in downplaying the political risk, but increased uncertainty may lead to surprises.
Public finances have been the economy’s Achilles’ heel for a long time and the main reason Greece was forced to undertake the biggest-ever sovereign debt restructuring in history. Unlike other eurozone countries, the Greek private sector debt has been modest and manageable. Of course, the loss of international competitiveness in the years after joining the euro in 2001 also constituted a problem and this is perhaps more important for the economy’s long-term health. After all, it was the country’s cut-off from market financing in the spring of 2010 on the back of chronic large budget deficits, leading to a huge public debt and an unprecedented crisis mismanagement by the PASOK government at the time which did the damage.
So, the markets are right to look at Greece’s underlying fiscal position, especially the primary budget and the cyclically-adjusted primary balance, and to conclude that it is in relatively good shape and likely to get better. They are not like some academics who draw conclusions about the fiscal situation by including one-off items, such as money spent on bank recapitalization, already burdening the debt, in the primary balance or others who apparently disagree with established international government accounting rules.
Market participants, especially bond investors and speculators, are also right to look at the profile of the Greek public debt and see it carries a low funding rate and a small refinancing risk with annual redemptions ranging between 4 and 10 billion euros after 2015. And this is before the much-touted debt relief measures. They all understand that they will get their money back in full while enjoying a yield pickup compared to other eurozone securities when they buy into bonds issued by the state or state-controlled companies like Public Power Corporation (PPC). This perception helped the state raise 3 billion euros by selling five-year bonds in April and PPC raise 700 million euros by selling three- and five-year paper.
In addition, the markets understand that the economy cannot remain depressed forever and it will recover. This is likely to coincide with the phasing out of fiscal austerity measures, an expected good tourism season and a likely rebound in investment spending from extraordinary low levels that may come as soon as this year. The recovery story and a low share price, compensating for the perceived risk, explains why real money accounts and hedge funds from abroad participated in the share capital increase of Eurobank lately and Piraeus’s and Alpha Bank’s before that, spending more than 5 billion euros in total. It could also explain why they may give National Bank the 2.5 billion euros it is seeking in the next few days.
Market participants rightly assume that Greece will remain in the eurozone and abide by its rules. From their point of view, this means their investments will be protected in case any Greek government decides to act irrationally in the future.
“Is there any major political party advocating Greece’s exit from the eurozone?,” Mark Mobius, the guru of emerging markets, had answered last fall in Athens after being asked to assess the political risk in relation to privatizations and potential bank capital enhancements.
This is the prevailing view among international investors even now. And although this view is fundamentally right, Greek political risk may manifest itself in the next three weeks, following the outcome of the European Parliament elections. So far, most polls show the leftist SYRIZA party leading conservative New Democracy by a relatively small margin, usually ranging between 0.5 and 3 points, and the junior coalition partner PASOK party doing poorly. However, these estimates should be viewed with a lot of caution.
According to pollsters, it takes multiple phone calls to people to get the same sample compared to the past as many people hang up the phone when they hear what it is all about and sometimes even resort to insults. So, the margin of error is much bigger than it used to be and the election outcome will be affected by the decision of many who are angry on whether to vote or not. At this point, it looks as if SYRIZA does not have the momentum one would have expected going into the final stretch. This may herald problems for the party if some of the traditional PASOK voters who have flocked to SYRIZA go back to their roots or vote for somebody else. One may argue it also looks good for the conservatives but it will mean little if New Democracy trails the leftist party by more than 4 points. In the latter case and depending on PASOK’s performance under the umbrella of Elia, the political risk will rise sharply.
All-in-all, the markets have reasons to take a more sanguine view of the macroeconomic situation and political risk in the medium-to-long term. However, they may have underestimated political risk on the shorter-time horizon. Although most opinion polls back their view, pointing to a benign election scenario on May 25, social discontent and higher uncertainty may hide surprises. Political risk should not be ignored.