By Dimitris Kontogiannis
The Greek economy is in the process of rebalancing as a result of the collapse of domestic demand, but the cost is quite high on a social and economic level. Whether the adjustment can be made politically and socially acceptable will partly depend on the capacity of banks to supply credit to the private sector. This means banks will have to deal effectively with their non-performing loans, which may include transferring them to a bad bank or/and selling them to distress funds. Neither option is easy.
Greece is on its way to producing the first primary general government budget surplus since 2002 and to nearly closing the current account balance gap this year, as troika representatives will likely confirm in their next report. The rebalancing mostly reflects the sharp contraction of domestic demand, as exports of goods and services (in volume) have yet to recover from the nearly 20 percent drop since 2009. However, a good tourist season has contributed positively to the GDP this year.
The sharp drop of domestic demand was, of course, inevitable given that the country had been living beyond its means for a long period of time. However, excessive austerity, manifested by a large surplus in the cyclically-adjusted primary budget-to-GDP ratio, equal to 6 percent, has resulted in an overshooting of the contraction in private consumption and investment spending. This has aggravated the economic slump and driven unemployment to 27 percent in the second quarter of 2013.
Although the compression of private consumption may be viewed in a more positive light – as a portion was channeled into imports, augmenting the chronic trade deficit – the collapse of private investment is not at all welcome as it erodes the stock of capital and hampers the country’s future growth prospects. Spending for plants and equipment has dropped sharply since its peak in 2007, falling to an estimated 13 percent of GDP this year from almost 27 percent in 2007 and about 19 percent in 2009, the year prior to Greece resorting to bailout funding.
But the recovery of investment spending depends on a host of factors, including restoring confidence in the country’s prospects. The rebalancing of the economy should help, along with signs of stabilization ahead from leading indicators such as the PMI and the economic sentiment index. A slower rate of decline in the sales of hard-hit industries such as cement, where demand has dropped to 2.5 million tons – last seen in 1963 – also point to a possible trough in economic activity for this cycle in 2013. The deceleration in the contraction of GDP in Q2 and the positive seasonally-adjusted quarterly change in the GDP point in the same direction.
With the public sector expected to remain on a strict diet for quite some time, exports and investment are the sources of demand that can return the economy to a growth path. Exports should continue to contribute positively, especially if economic activity in the eurozone recovers, but a question mark remains in relation to investment spending. In theory, investment spending should rebound after such a long slump once businesses feel confident that the economy will recover from the doldrums and rebalancing is on sound footing. On the other hand, the large sovereign debt overhang will continue to be a drag.
Bankers and others argue that domestic investment spending cannot rise in a sustainable fashion if the supply of credit to the private sector is not normalized. They say bank credit was the main financing source of investment projects in Greece in the past and express concern that investment spending will not rise as much as many expect unless credit institutions are in a position to resume normal lending.
Top bankers admit that it will not be easy as long as deposits do not grow, banks’ access to the interbank market is limited and access to wholesale markets remains nonexistent. Moreover, they agree that banks’ capital base will probably have to be further boosted to address any shortfalls that may show up in the new diagnostic tests of BlackRock Solutions. It is noted that the Troubled Assets Review, which assesses management policies of NPLs (non-performing loans) and restructured loans, should be available soon. The final Asset Quality Review (AQR/CLP), which will estimate the expected loss over a five-year period, should be available by end- November.
Notwithstanding the results of the stress tests, bankers feel they will have to deal with bad loans in order to provide working capital and to finance investment projects that are vital to the economy. Selling big chunks of non-performing corporate loan portfolios to foreign distress funds, for example, could help, though this may be impossible for two reasons. First, there is a big difference between banks and foreign funds when it comes to pricing these loans. Second, loan officers at local banks are unwilling to put their signature to any such deal, even if a selling price was agreed, as they fear any backlash down the road. “It is better to do nothing and let the loans run their course than risk being accused later on for misdoing,” says one senior banker.
The transfer of certain types of bad loans to a newly created asset management company could be a way out. The state or the Hellenic Financial Stability Fund could be either the sole shareholder or have a non-majority stake with private investors holding the rest, following the example of Spanish Sareb. The scope of assets and the transfer price could be determined in a fair way so that those two obstacles are removed, though even this solution is not ideal.
Either way, Greek banks will have to cleanse their books of bad loans, mainly corporate ones as mortgages are a political hot potato, to be able to fund investments and help propel the economy. It would be better all round if the sale or transfer of non-performing loans to an asset management company – a la Spain – or distress funds is facilitated.