Without a boost to the economy, last week’s deals mean nothing

Greece is going to take advantage of last week’s favorable developments at the European Union leaders’ summit to raise billions of euros in order to fund its sizable borrowing needs this week, although it is likely to pay the punitive interest rates it was trying to avoid. However, its success in borrowing at much better terms in the future clearly depends on its ability to jump-start the economy and the signs are not good. There is no doubt that German Chancellor Angela Merkel got what she wanted by having Greece’s EU partners adopt the kind of European Monetary Union / International Monetary Fund financial support package she favored all along. The aid package is likely to convince potential buyers of Greek bonds that the country can count on financial backing and therefore will not risk losing their money should the country default, at least in the foreseeable future. But it is not based on concessions and is only available under certain conditions, putting pressure on the government to meet its deficit targets. This is far from the kind of support package Greek government officials were hoping for. That would have been a large credit line of 25 to 40 billion euros available at any time and at a much lower interest rate than what is currently prevailing on capital markets. Given the country’s refinancing needs of over 20 billion euros by the end of May, the credit line would have had a dampening effect on the country’s yield spreads over Germany. So Greece will have to refinance over 10 billion euros in expiring bonds at the «barbaric» interest rates at which it refused to deal in the last few weeks, before experiencing a significant drop in spreads, according to bankers. The effect on Greek bond spreads may have been less had it not been for Jean-Claude Trichet’s surprising announcement during the summit. The European Central Bank president said the ECB will extend beyond 2010 the current collateral rules governing the credit rating of state and corporate bonds that banks can use with the ECB to obtain funds. Greek banks have borrowed more than 65 billion euros from the ECB at the refinancing rate by placing Greek bonds and other securities as collateral. Without this funding, the Greek economy would have faced a depression, as banks would have needed to cut back on loans. Even so, Greece has a lot more work to do in order to have easier access to the global capital markets and bring down its cost of borrowing via lower spreads. The required fiscal consolidation over the 2010-12 period is very demanding by any means and austerity measures must be followed by structural measures, such as overhauling the social security system, to make the effort more credible. Also, the ambitious budgetary targets cited in the Greek Stability Plan would have been more easily met had the economy been able to avoid a deep recession this year and start a recovery next year. With a sizable increase in direct and indirect taxes this year and next, some spending cuts in the public sector and with unemployment expected to rise, it is reasonable to expect that private and public consumption spending will be hit hard. Since private consumption accounts for more than 71 percent of gross domestic product, it is easy to see that it will take nothing short of a miracle for Greece to avoid a recession in 2010 as well. It should be noted the economy shrank by 2 percent in 2009 and most economists expect it to contract by 2-3 percent in 2010. With consumption compressed, the only other two sources of hope for the economy are net exports and investment spending. Most analysts expect imports to drop significantly this year, as consumers and businesses limit their purchases of goods and services from abroad, while exports are predicted to advance on the back of stronger growth in the world economy and eurozone in particular. This means net exports will be less of a drag on the economy than last year, providing a boost. However, the big question has to do with investment spending. If the latter recovers, the blow to the economy from the expected drop in consumer spending could be contained. The signs on this front are not good. Businessmen from various sectors are complaining that state bureaucracy continues to view investment projects with suspicion and civil servants continue as before, showing no understanding of the situation. Some of these businesspeople say the Public Investment Program has stalled and no public works have been awarded since the fall. Others say projects co-funded by the EU have also stalled, depriving the budget of EU money at a very difficult juncture. Public-private partnership projects have also fallen behind. The fact that loans from banks are more difficult and costly to obtain have made things even worse at a time when domestic demand is weak. These businesspeople are warning that the economy risks falling into a protracted recession if investment spending does not recover. They are right. In this regard, it may be very important for the government to start paying more attention to removing the barriers to investment instead of simply focusing on the implementation of fiscal measures to reduce the deficit.