Is the gloom justified?

The Greek stock market has been on an upward trend for months, beating even the most optimistic forecasts, as foreign funds continue to buy blue chips and selected mid-caps and the long-term government bonds have been trading at record low yield spreads over Germany, both markets taking an optimistic view of the future course of the local economy. On the other hand, the impression one gets from talking to businessmen, ordinary salary-earners, small shopkeepers and even local market participants is the opposite, as the majority paints the picture of a deteriorating real economy. So, who is right and who is wrong? Or perhaps are all of them right? In a sign of increased confidence in the ability of Greek companies to deliver superior earnings results, foreign institutional portfolios have flocked to the Athens bourse, sending the main general stock index to fresh three-year highs. Already, the MSCI-Greece stock index ranks first among all developed markets, returning close to 10 percent year-to-date. Pro-cyclical stocks, such as bank stocks and consumer companies with a big chunk of their sales coming from abroad, have been the top picks of foreign funds, seeking exposure to the Greek stock market. The impressive returns of the Greek bourse over the last two years and other similarities have already prompted some analysts to compare the Athens bourse to its Austrian counterpart. First, the major listed companies, such as banks, in both countries have been expanding in neighboring countries seeking future growth drivers. Whereas Austrian companies have been mainly involved in central European countries, such as Hungary, Greek companies have been expanding in the Balkans. So, major companies in both countries have an emerging market growth component to show and foreign funds seem to like it. Second, both countries are governed by center-right governments that have made similar decisions on cutting corporate taxes. The Austrian government announced a 10 percentage point tax cut on corporate profits effective 2005 upon its re-election in the spring of 2003 and the Greek center-right government stated its decision to proceed with the same tax cut a few months after its election last year. Unlike its Austrian counterpart, the Greek corporate tax cut will be implemented gradually over a three-year period, starting in 2005, to finally reach 25 percent from 35 percent in 2004. In this regard, the out-performance of the Athens bourse should be mainly attributed to the appetite of foreign funds for fast growing local companies expanding in the Balkans. Although this may be true, it is not entirely correct. After all, the vast majority of Greek stocks showing up on the radar screens of foreign investors still derive most of their revenues and earnings from their Greek operations and are expected to do the same for some years to come. So, if it is a bet, it is certainly not a one-way but a two-way bet. Most of them being cyclical stocks, this means the Greek economy should continue to do well for them to do well. This, in turn, suggests that the superior returns of the Athens Stock Exchange reflect, at least to some extent, positive expectations about high Greek GDP growth rates in the 2005-2006 period. In this context, even a 3.0 percent growth rate, perhaps inadequate for Greece’s demanding fiscal situation, is considered satisfactory. Good bond performance If the stock market discounts a brighter future for the Greek economy, the bond market apparently seems to downplay the likelihood of fiscal strains, resulting in debt payment servicing problems ahead. Greece’s participation in the eurozone seems to have played a major role in suppressing market concerns, despite its huge budget deficit and public debt load. Moreover, ample liquidity and the quest for extra yields by hungry fixed-income investors in a period of near record-low interest rates have kept the 10-year spread over Germany in check. In this regard, the tight yield spread over bunds may relate more to liquidity and Greece’s membership in the eurozone than to the market’s belief the country will be able to bring its budget deficit below the 3.0 percent of GDP threshold this year or next. Although in its infancy, a few market participants and businessmen have expressed reservations about Greece’s ability to reduce its budget gap below the 3.0 percent of GDP ratio without taking new austerity measures. This in turn has raised concerns about the impact on economic growth, as Greece is facing disciplinary action, having been put under EU supervision. These people have already started making references to Portugal’s unpleasant economic experience the last few years. It should be remembered that the center-right Portuguese government proceeded with a fiscal audit in 2002 that put the budget deficit of the previous year at 4.2 percent of GDP. This prompted EU authorities to intervene, demanding that the budget deficit threshold be respected. The Portuguese government responded by raising taxes which hurt economic growth. Unlike Portugal Although no one can rule out a repetition of the Portuguese experience in Greece, chances are that this will not happen. After all, Finance Minister Giorgos Alogoskoufis has repeatedly stated that it is not the government’s intention to raise taxes to tackle the problem and will focus instead on controlling expenditure spending to bring about the desired outcome. Still, the fact that the Portuguese experience has been on some people’s mind appears to make things worse, not better, since it contributes to the deterioration of the economic climate; although a recent survey released by IOBE, an economic think tank linked to the Federation of Greek Industries, showed an improvement in January after several months. Still, the disappointment easily seen among people of different social strata translates into negative expectations about jobs and economic growth. Is this the result of the famous tendency by many Greeks to paint a situation in darker colors than it warrants or is it an accurate depiction of a deteriorating economic reality, which contrasts the one discounted by the stock market? Time will show, but most likely it is both, as some segments of the Greek economy come under further or renewed pressure in a more competitive landscape underpinned by fiscal austerity.

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