Austerity measures are bound to hurt the Greek economy even more as it strives to bring its public finances under control.
However, the situation may be aggravated if the economy experiences a liquidity crunch as local banks face the prospect of cutbacks in their funding from the European Central Bank (ECB) in coming quarters and years.
It must have become obvious by now that Greece will not be able to service its huge public debt unless the economy returns to growth and a way is found to lighten its debt load by more than the 50-billion-euro sum sought by privatizations and the sale of certain public real estate assets in the next few years.
Nevertheless, the return to satisfactory growth rates in the next two years has become even more challenging due to two factors.
First, the planned imposition of new austerity budget measures owing to the conditionality of the economic policy program agreed with the European Commission (EC) and the IMF.
Second, the deleveraging in which local banks have embarked to comply with the ECB?s call for a gradual reduction in their dependency on eurosystem funding.
This is not good news for the Greek economy, which shrank a cumulative 6.5 percent in 2009-2010 and is likely to contract by an additional 3 percent this year, pushing the underestimated unemployment rate to more than 15 percent of the labor force. Perhaps even worse than that may be the prospect of weaker than projected in the economic program real GDP growth in 2012 and 2013. If realized, this may entail even more austerity measures to attain the budget deficit goal in those years.
Although most analysts expect a rather significant pickup in the exports of goods and services this year, the small size of the sector relative to the Greek economy makes its impact less noticeable despite an anticipated positive contribution from a drop in imports for another year.
It is noted that the sharp fall in private consumption spending mainly due to contracted disposable income and other effects such as the negative wealth effect from lower financial and real estate values has had a dampening impact on imports.
This, along with a relatively small increase in exports, proved to be a smaller drag to the Greek economy than usually in 2010, partially offsetting the negative contribution from sharply contracted consumption spending.
Still, the economic situation does not look promising as new spending cuts and revenue enhancing measures will come into effect at some point during the year.
Even more cause for concerns comes from the liquidity conditions in the Greek economy as banks continue to face deposits withdrawals to the tune of 6 billion euros in January-February according to bankers? estimates.
With the wholesale and interbank market freeze still in place and local banks coming under a new round of credit downgrades since the start of the year, reducing their ECB-eligible collateral values, Greek credit institutions appear to have relied even more on ECB funding to close their liquidity gap, borrowing some 98 billion euros according to the latest figures from around 94-95 billion euros before. It is noted banks can borrow from the central bank by posting eligible collateral such as government guaranteed securities, government bonds etc.
The ECB has gone out of its way to help them in the past, i.e. suspending the minimum credit rating floors in the collateral eligibility requirement on Greek government bonds, but along with other members of the troika appears to be asking banks to plan to reduce their dependency from this source of funding.
Already some local banks have tried to cope with the hemorrhage of deposits by providing fewer loans to keep their loan-to-deposit ratio from rising and complying to as much as possible with the calls of the so-called troika — that is the representatives of the EC, IMF and the ECB — for less funding from the eurosystem.
But the negative dynamics in retail deposits will most likely persist in 2011 and deposit withdrawals may exceed 20 billion euros in total according to some estimates.
Notwithstanding the contradiction of the Greek state issuing additional state guarantees so banks have enough collateral for ECB funding at the same time the troika advises for gradual disengagement from this practice, one cannot ignore the impact on the real economy.
It is known that new loans help boost deposits and therefore the opposite is happening as banks go into reverse. So, the withdrawal of deposits from local households and corporations can be partly explained by this factor in addition to the more obvious of smoothing out their spending pattern.
Therefore, the implicit encouragement of deleveraging by the ECB and the rest of the troika when the economy contracts will add to deposit withdrawals and increase the Greek banks? liquidity deficit.
This will lead to a vicious cycle as banks will be forced to fire sell assets and cut back on new lending to conform with the stricter ECB requirement and the wholesale/interbank markets.
Of course, Greek banks will at some point have to drastically reduce their dependency from cheap ECB funding.
However, doing so under the prevailing circumstances amounts to a self-defeating exercise of smaller deposits and more deleveraging, hurting the real economy and aggravating the debt problem.