Investors’ trust waning

What a difference two months can make. Foreign investment bankers, fund managers and analysts on the Greek economy and markets were providing a much more upbeat assessment on Greece’s prospects back in early March than they do now. With most of their local colleagues remaining on the pessimists’ camp, the ebbing of optimism among the most profound believers in the so-called Greek story of growth means the authorities have not succeeded in convincing their most important allies that a fresh start is underway. Although outside factors are partly to blame for this, the government has no choice but to change the trend. If it does not, the government will find it more difficult to attain its economic goals in the next couple of years or so, putting at risk even its undisputed political dominance of recent weeks and months. Of course, the Greek government should not be blamed entirely for what appear to be declining expectations on the part of foreign investment bankers, analysts say. Rising risk aversion among international investors on the back of tighter liquidity conditions, linked to forecasts for more US interest rate hikes by the US Federal Reserve and concerns about much slower world GDP growth ahead, have taken its toll on Greek stocks and government bonds. Growing risk aversion The reduced appetite of foreign institutional investors for risky assets, especially equities, has pressured bourses. The Athens Stock Exchange has been no exception. Initially some non-resident funds, investing primarily in European emerging market equities, sold Greek banking shares they had bought, counting on local banks’ exposure to neighboring Balkan countries to bear fruit in the future. Although bank shares recovered immediately after that round of selling, they have been unable to reach their previous highs, encountering new pockets of resistance along the way, with the most recent having been felt a week or so ago. With heavyweight banks unable to recover the lost ground and telecommunications stocks unable to fill the gap, it was no surprise that the Athens composite stock index slid towards 2800 points, a year low, intra-day last Wednesday. Bonds hit, too Greek stocks have not been alone in taking some beatings in the last couple of months. Greek government bonds have not done well either. The most popular yardstick, their 10-year yield spread over Bunds, the German government bonds, has widened to about 27 basis points lately from some 19 basis points at the beginning of the year. It is noted that one percentage point equals 100 basis points. In addition to tighter liquidity conditions, the shift of investor preference toward core eurozone country bonds and away from non-core bonds, such as Greece’s and Italy’s, has been underlined by opinion polls showing the French were likely to vote No on the European Constitutional Treaty in their referendum on May 29. A No vote is regarded by fixed-income markets as a setback to convergence, making them more prone to discriminate between bonds of the eurozone countries, leading to wider yield spreads. Wider yield spreads translate into higher borrowing costs for countries, making fiscal consolidation more difficult and more painful in terms of economic output. Notwithstanding the contribution of outside factors, such as tighter global liquidity conditions and an increase in risk aversion demonstrated by larger risk premiums and the likelihood of a rejection of the European Constitution in the French referendum, Greek assets have been sluggish on purely domestic reasons. The yield spread of Greek government bonds over Germany started to widen on news of the country’s huge fiscal imbalances, culminating in a budget deficit estimated at more than 6.0 percent of GDP in 2004. If it were not for the country’s huge budget deficit and public debt, it is doubtful Greek bonds would have attracted the attention of traders and others, looking to bet on events such as the outcome of the French referendum on the European Constitutional Treaty. Shorting Greek 10-year bonds while buying Italian 10-year bonds was one of the most popular trades at the height of speculation that the French would vote No on May 29. This explains why it was not only Greece’s 10-year yield spread over Germany which expanded during this period but its 10-year spread over Italy as well. So, Greece’s deeply rooted public imbalances coupled with outside events have contributed to the disappointing performance of Greek state bonds. In addition to fixed-income market participants, signs of declining optimism are easily detected among foreign investors and others who are on the equity market side. Slow progress on the privatization front and on structural economic reforms is the root of the problem in this area. Those on the equity side may comprehend and even applaud the government’s domestically unpopular tax hikes, since they bring in permanent tax revenues to close the budget hole without inflicting much damage to GDP growth. However, they do not seem to understand the delays in some other long-awaited projects such as the part-flotation of the state-controlled lottery company OPAP. The later is now expected to take place in late June or early July at best. One may attribute the declining optimism on lower-than-expected fees and commissions from Greek business, mainly state-sector related. Even if this is so, the government needs their help to turn around the economy and cannot afford to disappoint them if it wants to meet its economic goals and be re-elected a few years from now. So it has no option but to push ahead with structural reforms and speed up privatizations.