Cyclically-adjusted data reveals a different picture

Greece will not be able to get out of its nightmare if it does not manage to change the perception of others, such as market participants, foreign politicians and the mainstream foreign press, about its commitment to put public finances in order and modernize the economy. It could start with the use of the cyclically-adjusted budget which provides a glimpse into how tax-tilted austerity has brought the economy to its knees and masked the underlying fiscal progress.

It may be a bit early since the PSI (Private Sector Involvement) has not yet been completed, but the market assigns a high probability to another public debt restructuring in the future, judging from the inverted yield curve of the new Greek bonds and the accompanied double- digit yields. It is noted that an inverted yield curve arises when the short-term yields are higher than the yields offered by long-term bonds.

In other words, bond market participants think the new economic program will fail to meet its budget deficit targets, creating a financing gap that will have to be filled by additional funds from the official sector and/or another restructuring of the Greek public debt. If indeed, an additional financing gap arises and no extra official loans or/and debt relief materializes, Greece will likely default.

This unwelcome development may be discouraging but it is quite predictable from the point of view of a bond trader who sits in London or New York or elsewhere and looks at the numbers. Greece will get a debt relief of 100-107 billion euros from PSI and a new EFSF/IMF loan of 130 billion euros of which only 19-20 percent or 25 billion euros will finance government needs.

When the exercise is over, the Greek public debt-to-GDP ratio will still be around 160 percent or higher, making it very hard for the country to access the markets down the road. The fact that PSI improves the cash flows of the budget by saving more than 3 billion euros in interest expenses annually and reducing the refinancing risk are less important from the traders? point of view at this point.

The new Greek government will have a very difficult task to change these market perceptions but it will be easier to use data from the Organization for Economic Cooperation and Development (OECD) to show Greeks work more hours per year on average in the eurozone to combat this stereotype, which is evident in some northern EU countries.

However, the new government could begin the long journey to change market perceptions about the long-term sustainability of the public debt by making something else clear: On the one hand, the country has adhered to austerity pledges to cut the budget deficit, resulting in a deeper recession. On the other, it has not kept many of the reform pledges but intends to do so from now on.

There is plenty of data to support both the argument of progress in slashing the budget gap by more than the raw figures show and prove how inefficient and self-defeating the heavily tax-tilted austerity policies have been.

One has just to look at the so-called cyclically-adjusted government budget balance figures put out by the European Commission. The idea behind this reading of the budget balance has been to remove the so-called cyclical component from total revenues and expenditures to demonstrate the country?s fiscal stance.

Since the budget is interlinked with the business cycle, removing the part of revenues and expenditures associated with the ups and downs of the economy provides a better picture of the country?s fiscal policies and degree of consolidation.

By looking at the cyclically-adjusted government budget deficit calculated by the European Commission last autumn, one can immediately detect both the fiscal policies in place and the extent of fiscal adjustment.

According to the forecasts, actual revenues stood at 38 percent of GDP in 2009 — an election year — rose to 39.5 percent in 2010 and are projected at 41.4 percent of GDP in 2011, despite an economy contracting at annual rates of 3.2 percent in 2009, 3.5 percent in 2010 and 5.5 percent in 2011. The GDP is measured in 2000 market prices so the figures will likely be revised downwards for 2010 and 2011.

However, total revenues adjusted for the ups and downs of the economy displayed a clearer picture of the large tax burden shouldered by households and companies. The adjusted revenues stood at 39.9 percent of GDP in 2008 and dipped to 38.6 percent in 2009, but went straight up to 41.3 percent of GDP in 2010 and rose even further to 44.8 percent of GDP in 2011.

Moreover, the Commission projected that the adjusted revenues will rise to 46.5 percent of GDP in 2012 with actual revenues increasing to 42.5 percent. But the adjusted revenue-to-GDP ratio should be likely even higher in both 2011 and 2012 since the Greek economy is projected to contract by 6.5 to 7.0 percent last year and 3.5 to 5.0 percent in 2012.

Budget expenditures, both actual and cyclically-adjusted, have been moving broadly in line estimated at 50.2-50.3 percent of GDP in 2011 from 50-50.1 percent in 2010 and a record-high 53.8 percent in 2009. The actual and cyclically revised budget expenditures are projected at 49.3-49.4 percent in 2012.

When put together, the resulting actual budget deficit is seen at 7 percent of GDP in 2012 from 8.9 percent in 2011 and 10.6 percent in 2010. But the cyclically-adjusted budget deficit is projected at 2.9 percent of GDP in 2012 from 5.3 percent of 2011 and 8.7 percent in 2010.

These budget figures clearly show that the Greek economy has been administered a heavier dose of taxation than it should have been while spending escaped unscathed. This policy has been largely self-defeating, since it brought the economy to its knees, producing a bigger headline deficit and masking underlying fiscal progress. Moreover, it helped undermine market confidence and create persistent damaging perceptions about Greece that will take a lot of effort and time to change. Focusing on the cyclically-adjusted budget deficit may be a good way to begin.

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