Markets keep government in check

The good news is the Greek economy advanced for the first time since 2008 in the two previous quarters. The bad news is it continues to be hostage to political risk, as the markets show by continuing to take a negative view of Greek bonds and stocks. In addition, the coalition government does not seem satisfied with the Eurogroup’s offer of a precautionary credit line (ECCL) from the European Stability Mechanism (ESM), assuming the review of the economic program is completed, if it is not accompanied by debt relief measures and a more limited role for the IMF. The political puzzle will be resolved at some point next year but in the meantime may leave deep scars on the economy for quite some time to come.

On Friday, the Hellenic Statistical Authority (ELSTAT) revised its real GDP estimate upward for the second quarter of this year, showing the economy advanced, and released its flash GDP estimate of 1.7 percent year-on-year growth for the July-September period, confirming market expectations. The main stock index at the Athens bourse responded by recording mild gains of 0.81 percent on the news, trimming its losses to a bit above 20 percent in the last three months.

On the other hand, the benchmark 10-year bond saw its yield rise to 8.08 percent while the 5-year bond yield eased to 7.2 percent. It is clear the markets have discounted some news and taken a wait-and-see attitude in view of political developments in the next few months. Another way to interpret their stance is to say the markets are warning all involved, especially the Greeks but the EU as well, there is the potential for a big mess.

As days go by and negotiations between the government and the troika drag on, the likelihood both sides may not be able to reach an agreement, concluding the last review of the current adjustment program before December 8, when the finance ministers of the eurozone meet again, rises. Although the government’s partial retreat on the issue of up to 100 installments for past overdue taxes and social contributions has helped, the two sides continue to be apart on many issues. Pundits say the 19 points-issues cited recently in a leaked e-mail from the troika to Athens have been standing there for the last few months with none or little progress.

The German side and others have made it clear Greece will have to conclude the ongoing review before getting the Eurogroup to agree to the ECCL precautionary line. However, some in the market doubt whether the government would like to pass legislation in Parliament containing unpopular measures, and face a political backlash just for getting this precautionary credit line. They add the EU should make it easier for Prime Minister Antonis Samaras by agreeing to a set of debt relief measures and a new, limited role for the IMF in the new regime as well.

This way Samaras can appear before Parliament next year with a package and seek the 180 votes needed to elect a new president and avoid early general elections with the leftist SYRIZA enjoying a clear lead in opinion polls. If the government does not get a carrot, they argue, it will have little incentive to seek the completion of the review and the passage of relevant legislation through Parliament. If this turns out to be the case, there will be no accord with the troika and Samaras may alternatively seek a similar deal from eurozone leaders at the EU Summit on December 18. This verbal deal could be his main card in going to Parliament and seeking the minimum 180 votes early next year, they argue.

Whether these political scenarios turn out to be true remains to be seen. In the meantime, the signs from the economic front are mixed, with tourism doing well but industrial production down. Also, the state’s arrears to third-party suppliers and other creditors are on the rise, signaling liquidity conditions may get tougher ahead for the private sector. Moreover, the government appears to be preparing for the possibility of early elections by favoring some populous interest groups.

While the government wants the remaining pension reforms in the current economic adjustment program to be implemented after the presidential election next year, to avoid the political cost of taking painful measures now, it is also taking steps which could make things worse. For example, the Labor Ministry is going to submit a draft law in Parliament in the next few days extending a number of privileges to military and security forces, civil servants and some bank employees from January 1, 2015 with regard to retirement. It is estimated Greece is paying more than 2 billion euros in pensions every year to retirees in their 50s. It is doubtful whether this legislative initiative and others will bring in more votes for the ruling parties, but it is certain they will worsen the financial situation of the social security system and ultimately shift the burden to the younger generations.

So the economy may indeed come out of its doldrums, and this is encouraging. But market participants are right to be worried about political uncertainty, thus keeping bond yields at highly prohibitive levels for Greece to borrow from the markets. Legislative initiatives, such as those of the Labor Ministry, may make political sense but do not make economic sense and certainly justify market caution about the medium-term implications of the ongoing political saga.

NOTE: The Greek economy grew by three consecutive quarters based on seasonally-adjusted GDP data. It grew by 1.4 percent and 0.4 percent year-on-year in the third and second quarter respectively. It advanced by 1.7 percent year-on-year based on unadjusted figures.

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