By Dimitris Kontogiannis
The heightened country risk has deterred foreign funds, banks and others from providing adequate financing to the Greek private sector for investments, prolonging the recession and contributing to the rise in unemployment. It is therefore important to take steps to mitigate the country risk by creating new financing tools that will encourage domestic and foreign participation in making more and cheaper liquidity available to private firms for investment projects.
It is well known that demand for funds by domestic companies interested in making productive investments has collapsed in the last few years. The numbers tell the story. Greek investment spending is half of what it was in 2007 as a percentage of GDP, estimated around 13.2 percent of GDP this year compared to 26.7 percent in 2007, which appears to have been the best year for investment spending in the last few decades. In a troubling sign for future economic activity, the country’s physical stock of capital shrank last year, meaning gross investment spending on plants, equipment, technology and property lagged behind depreciation, which accounts for the wear, tear and obsolescence of capital assets, according to economists.
Undoubtedly, Greece was never the best place to invest in the world because of the enormous bureaucracy, the ever-changing tax laws, the lack of zoning and other factors. But an effort is being made to correct some of these deficiencies in the context of the adjustment program, though it will take some time before it bears fruit. So, it is the dismal current state and the uncertain outlook of the economy that largely explain the sharp drop of investment spending in the last few years and therefore the inadequate demand for funds destined for productive investments. So, one should expect the acquisition of new plants and equipment to pick up alongside the rebound of economic activity. If the government and the troika are right, this should start happening next year since the economy is projected to grow by 0.6 percent in real terms.
In addition to tackling the issues related to the demand side of the equation for investments, we should also look at the supply of funds. There is no question that Greek banks will be much more cautious and apply stricter lending criteria for long-term financing to private firms following their recapitalization and the high portion of non-performing loans in their books. This means the interest rate charged on these loans will reflect the credit rating of the firms and will be high, leading to a lower IRR (Internal Rate of Return) which is a method used for measuring and comparing the profitability of investment projects.
Moreover, banks will seek in general a bigger equity participation by the firms or their owners, at least as long as the macroeconomic environment is not rosy, and require collateral. According to bankers, large loans extended to corporations in the past did not require collateral. Of course, some large firms have turned to wholesale markets to raise medium-term financing for projects or/and refinance maturing bank loans in a bid to differentiate their sources of funds.
Undoubtedly, the country will have to do more to supply more and cheaper funding to small and big firms to fund investments as the economy comes out of its long, deep recession, bordering depression, and have structural reforms tackle some of the issues, prohibiting investments. So, new financing tools and mechanisms have to be put in place to do the job, drawing from the experience of other countries.
Economics Professor Plutarchos Sakellaris, former vice president at the European Investment Bank (EIB), has suggested a way to help attract foreign funds for investments, kept away by the country’s perceived high risk. The idea is centered on the provision of partial insurance against first losses and the creation of a portfolio of productive investments, ranked according to their distinct risk characteristics.
Since it is in Greece’s best interest to attract these foreign funds, the state could provide partial insurance by using money from the Public Investment Budget in one year or available EU funds (National Strategic Reference Framework). International financial organizations with strong balance sheets, such as the EIB, EBRD, IFC, etc could supplement the state’s share. Private investors could also join in, knowing they would be taking a smaller risk.
Basically, Sakellaris proposes setting up a fund with a specific lifetime, i.e. 10 years, which would supply credit for productive investments carried out by firms or independent project finance. The financing of this fund would be organized in three tranches based on the assumed risk. The junior tranche would belong to the state and would be the first to be reduced if losses are incurred from the investments. The middle tranche would correspond to the participation of the international financial organizations and would be less risky since it is preceded by the first layer, while the senior tranche would go to private investors.
Undoubtedly, Greece will have to come up with structures such as the proposed fund by Sakellaris, resembling the European Fund for Southern Europe (EFSE) and the Green for Growth Fund, to mitigate the country risk and supply more and cheaper debt financing and even equity participation for investment projects. The Institute for Growth, run by the Greek Development Ministry, the EIB and the German state bank KfW, may fit this model.