Athens facing a daunting task

The formation of a new, temporary unity government under former European Central Bank Vice President Lucas Papademos is a step in the right direction despite the poor track record of coalition governments in Greece.

However, the outlook for the Greek economy remains cloudy at best, putting at risk the country?s membership in the eurozone.

We have long held that the mismanagement of the Greek crisis by the Socialist government under George Papandreou has augmented existing imbalances and economic problems dating back to the 1970s, bringing the country to its knees. The referendum on the euro was the latest mistake, aggravating an already difficult situation for the country at home and abroad.

Leaving aside the weakening of Greece?s negotiating position abroad caused by the ill-thought referendum, one can easily identify two other conflicting consequences at home. On the positive side, a large portion of the Greek public now realizes that there is a real danger the country may exit the eurozone and that various scenarios which have appeared in the foreign press were not theoretical but actually have some credence.

On the negative side, this realization has prompted some to withdraw their deposits from local credit institutions, putting more pressure on the liquidity of the local banking system. Although banks are currently able to fill the hole opened by the drop in deposits via the Bank of Greece?s emergency liquidity mechanism, it does not bode well for the economy since they cannot afford to satisfy at reasonable interest rates even the weak demand from creditworthy companies and individuals.

Analysts agree that foreign direct investments, a pickup in exports, a vast improvement in the absorption of EU structural funds and ample funding to the private sector by the banking sector are needed to counterbalance the adverse effects of continuous fiscal tightening, wage cuts and rising unemployment on the national economy.

But it is hard to see any positive developments which could change market sentiment and the economic equation on all these fronts. Even if we ignore the partisan fights which are likely to resurface as we draw closer to general elections at some point in the first quarter of 2012 and the temporary government delivers on the main points to secure the disbursement of the sixth tranche of 8 billion euros from the EU and the IMF under the first economic adjustment program, we doubt whether this is enough.

By all accounts, the newly set budget deficit target for 2011 will be missed and the only question is by how much. The deficit was set initially at some 17 billion euros but is likely to exceed 19 billion or even more as revenues from extra taxes miss goals.

At the same time, the public debt-to-GDP ratio is likely to exceed 160 percent and end at closer to 163 percent with its dynamics becoming even worse for 2012 without the positive contribution from the so-called PSI Plus, the new bond exchange program which includes a 50 percent haircut on Greek marketable debt.

Just to remind everybody, the country?s central government debt-to-GDP stood at 32.8 percent in 1981 with the budget deficit at 9.8 percent of GDP. The same debt ratio went up to 71.4 percent of GDP in 1990 with the deficit at 13.6 percent. The central government is the biggest component of the general government.

Back to the present: Greek politicians seem to be betting a lot on expected interest savings of some 4-5 billion euros, resulting from the prompt implementation of PSI Plus early next year but tend to forget they will need the approval of the so-called troika, the representatives of the EU, IMF and the ECB, to get some fiscal relief.

But it is not certain whether Greece?s official creditors will consent to something like this when the 2012 budget will have to make up for the 2011 fiscal slippage and there will be likely indications of further budget deficit misses in 2012.

Moreover, private investors seem to be demanding coupon rates of more than 6 percent on the new bonds to voluntarily participate in PSI Plus. If they succeed, this may affect projected interest savings since they will apply to Greek bonds with a nominal value of 100 billion euros or more if full participation is secured via collective action clauses.

In addition, it is hard to see how the country can collect the billions of proceeds earmarked from privatizations next year with asset prices depressed after the relatively easy part of extending or selling licenses to OPAP and others this year.

Undoubtedly, the sale of public property could bring in billions of euros, but this requires a better economic and political environment as well as ?clean? real estate assets in a country where preparatory work has not been done and all kinds of legal hurdles can be found.

All in all, the new unity government under respected former central banker Papademos is a major step forward for the country, but it may have come too late.

We are sure Papademos and many of his ministers will do their best to improve Greece?s tarnished image abroad but we are not so sure they will be equally successful in rallying the people domestically to stick to the austerity plan and meet the budget deficit targets.

The country?s economic outlook does not look promising.