Key to Greece’s economic recovery may lie in terse orders from Brussels
The new Greek socialist government may be sincere in its commitment to fiscal consolidation in the medium term. However, the only way to hedge this commitment against the political tide is to have Brussels demand concrete and unpopular measures to rationalize the public sector and restrict primary spending. Greece proved again last week that it is capable of inflicting great damage to itself. After doing its best to advertise its economic problems, it failed until Friday to present a united front to fend off an onslaught of aggressive short selling of its bonds and stocks by foreign speculators. Public statements by the central bank governor earlier last week – which caused friction with the government and prompted caustic off-the-record remarks by top commercial bankers, who felt the local banking system was unfairly criticized at a difficult juncture – and the lack of supportive statements by the government did little to stop the selling of local assets by foreign speculators and investors alike. Finally the government, banks and the central bank got their act together on Friday, helping calm the markets partially but it was too little, too late. Friday’s verbal intervention did not stop the ATHEX General Index from falling more than 6 percent on the week. The lack of strong buying interest for Greek liquid assets made it easier for speculators to short-sell stocks and bonds and the sell-off was reinforced by news that Dubai World, the state conglomerate, was seeking a six-month standstill on $59-billion worth of debt. The widely watched 10-year yield spread over Germany shot up to more than 210 basis points on Friday before falling off to about 192-194 basis points on strong buying by two large local banks. The latter forced speculators, who had sold short the Greek government paper, to rush to buy it back, accelerating the shrinkage of the yield spread, according to senior bankers. It is reminded that 1 percentage point equals 100 basis points. It is obvious that Greece has succeeded in becoming the center of world attention, given its chronic credibility deficit, high public debt-to-GDP ratio and the overshooting of its budget deficit target in 2009. In so doing, it stole the limelight from other countries with serious fiscal problems, like Ireland and Spain. As is usually the case, this leads to the sell-off of stocks and bonds, making it more expensive for the government to borrow next year to roll over its maturing public debt and finance the budget gap. Since it will take many months for the Greek government to convince the markets that it means business, it should be expected that the latter will put pressure on the country to deliver. «Even if the government makes the right noise, it will take months before the budget figures are counted and this will take us to September next year,» said a senior banker. In the meantime, Greece will have to go to the markets to borrow more than 50 billion euros without counting on the help of local banks as it did this year, when it raised some 67 billion euros. By all accounts, the country will have to pay a bigger yield spread to borrow the required sum next year. Assuming market expectations about higher euro money market rates are correct, this means it will have to pay a much higher interest rate on the new debt than it did in 2009 and perhaps 2008. Of course, things could get even worse if rumors about the transfer of large amounts of deposits from Greece to destinations abroad materializes. For a banking system with a loan-to-deposit ratio standing above 100 percent, this could be really bad news for all. The banks will be forced to pay more to borrow the necessary funds in international markets in order to replace the lost deposits or/and cut back on loan growth, which will hurt the Greek economy. Under these circumstances, the best of all possible worlds may be to have the European Commission impose certain rules on Greece to rationalize its public sector. Perhaps cutting salaries may be the wrong way to go but cutting all pay related to fake overtime work or other fringe benefits may be a good idea. The same holds true for imposing and monitoring a rule on new hirings and retirees in the public sector. Even if the Greek government has good intentions and is committed to fiscal consolidation, the truth is that the political cost of such actions to restrict primary spending is too high to be acceptable in the medium term. Therefore, Brussels will do a great favor to generations of Greeks if it helps the government hedge its fiscal commitment by making it imperative that it takes specific steps to overhaul the public sector.
