Cheap bank credit key to the economy
Austerity has played a significant role in prolonging the economic recession in Greece. However, other factors have also contributed to the downturn. Stringent financing conditions is among the most important of these, contributing to the steep decline in output since the crisis erupted.
The European Central Bank’s decision to cut its refinancing and marginal lending rates is a step in the right direction as far as Greece is concerned because it makes monetary policy looser and less supportive of a stronger euro. However, it is important that more steps are taken since thousands of local companies are walking a tightrope. Reducing their cost of funding and helping them avoid a disaster should be a priority so that economic recovery is not undermined further.
Some international lenders and a few others dispute that excessive fiscal austerity, measured by the change in the cyclically adjusted budget balance of the general government since 2010, has been the driving force behind Greece’s unprecedented GDP drop over the last few years. Still, a growing number of economists from different schools of thought and others argue that excessive austerity has been the most important factor behind the compression of economic activity, pushing unemployment over 27 percent.
Yet austerity is not the only factor in Greece’s dismal economic performance since the outbreak of the financial crisis in 2008 and the country’s request for a bailout in 2010. Tight financing conditions have also played a role, confirming the theory that, other things being constant (ceteris paribus), high real interest rate levels contribute to lower GDP growth and even cause recessions.
The stringent financing conditions reflect to a great extent the country’s perceived high credit risk, depicted in the spread of the Greek 10-year government bond over its German counterpart. The spread has come down considerably, falling to 659 basis points in early November compared to more than 1,000 points a year ago. It went up to 687 basis points on Friday, possibly reflecting the risks of left-wing SYRIZA party’s move to seek a vote of no-confidence in the coalition government. Note that one percentage point equals 100 basis points.
The large premium demanded by foreign investors to buy Greek state bonds reflects both the macroeconomic fundamentals, the limited liquidity of the new, post-PSI bonds and market sentiment. It has been a major deterrent for the sovereign tapping the world markets as well as for private corporations. Nevertheless, a few large companies took advantage of a window of opportunity a few months ago and tapped the market to raise hundreds of millions of euros. Three others, Eurobank Properties, Mytilineos and GEK-Terna, raised money by selling equity stakes to foreign funds, namely Fairfax.
Although financing conditions in the economy have improved somewhat in the last few months, they remain very tight. Bank credit to companies fell 4.7 percent year-on-year in September with the outstanding amount of loans standing at 105 billion euros from 107.3 billion at the end of 2012. Moreover, banks continue to apply very tight lending criteria with interest rates on corporate loans of up to one year ranging from 6 to 9 percent on average according to bank executives.
Pundits argue that the expected further reduction in the sovereign risk and Greek banks’ greater access to the interbank market following the new stress tests and recapitalization exercises, will pave the way for less stringent financing conditions. Unfortunately, the oligopolistic nature of the new banking landscape does not help since it favors less competition. In addition, the state, as the bigger shareholder via the HFSF, the private shareholders and the top brass of the banks want to boost profits. Obviously reducing time deposit rates fast and keeping lending rates elevated helps fulfill that goal.
Of course, demand for corporate loans to finance investment projects is lagging at this point. The demand relates mainly to working capital needs and that’s where the real problem lies, especially for small and medium-sized companies. The deep and protracted economic recession has caused domestic sales of most companies to drop in the last few years. Healthy firms have reduced their working capital in line with sales and therefore their demand for short-term loans has receded accordingly.
However, this is not the case with other companies that have seen their capital needs increase at the same time as their sales have dropped. The latter could be broken down into two main categories. In the first category, we have companies that need working capital to finance their operating expenses. They need the loans to stay alive but their fate is more or less sealed. Some may argue that it is a waste of resources to extend loans to these companies.
In the second category, there are companies that have seen their sales drop but need liquidity to buy raw materials and other things related to their turnover. The use of loans differentiates these companies from those in the first category. These firms face difficulties but logic dictates that banks ought to support them by providing loans until the time that the economy grows again so they can stand on their own. These companies do not just need loans; they need cheap bank credit to remain afloat until economic activity picks up.
The economy must get out of its long-term slump and looser financing conditions could play an important role. This is more so when it comes to banks providing cheap loans to small and medium-sized companies that face problems but can survive. The recent ECB action helps, but more is required, including a healthier fiscal position for the sovereign and structural funds.