Sunday, 17 January 2010

Latest Developments in the Greek Debt Forecast

I'll be updating my Greek debt forecast this week on the basis of the Stability and Growth Agreement, which the Ministry of Finance published last Thursday, and which I'm still going through.

My concerns are that nice rhetoric notwithstanding, PASOK does not have a plan to reduce the debt. I doubt the deficit targets can be reached. In particular, the deficit is supposed to be below 3% in 2012 or 2013, but we can expect an election in that year, so it’s highly doubtful that the deficit target will be met.

Don’t forget that in election years, the deficit increases because the party in power slacks off on tax collection and increases government hand-outs to favoured electoral groups like farmers or public sector employees. At the same time, the party vying for power makes extravagant promises, usually to the same electoral groups. That’s partly the reason Greece’s debt swelled from 6.7% of GDP before the October 2009 election to over 12% after the election: PASOK did push through many of its spending promises; ND slacked off on tax collection long before the election.

Yet even if the deficit is reduced, we should not forget that the total public debt remains. For those readers not versed in public sector economics:

• The annual deficit is the shortfall between public sector expenditure and revenue measured on an annual basis;

• The public debt is the total debt owed by the public sector to foreign or domestic creditors.

While deficits come or go, the debt stays with us, growing every year due to interest payments, until it is paid off.

Thus, if Greece has an annual deficit of 12% of GDP in 2009, or EUR 30 bln: this EUR 30 bln is added to the public debt. It should be clear to everyone that although reducing the annual deficit is a key priority (and a key indicator of success of public policy), the country needs measures to reduce the total debt. Interest, after all, is charged on the debt, not the deficit.

Add the demographic impact of the baby-boomer retirement, and the swelling (and unstated) IKA/OAEE debts, and the formula is toxic. We still do not know the total amount of government debt, because

(a) There are thousands of semi-government organisations which do not prepare budgets on time, do not prepare forecasts, and are incurring millions of Euros in losses every day.

(b) The “black hole” of government spending is social security. Last week, for instance, revealed that IKA owes over EUR 5 bln to OAED. We know that IKA owes billions to the hospitals and healthcare providers. And the demographic “bust”, as baby-boomers retire in Greece, will create major pressure on retirement spending. The OECD has estimated that Greece’s long-term, social security liabilities may be up to 200% of GDP, in other words, over EUR 500 bln.

If you think that Minister Loverdos’ negotiations of the social security issue, underway at the present time, will provide a sustainable, long-term answer, you are probably dreaming. There will be no sustainable solution without a major hike in social security contributions, particularly among the self-employed and independent professionals. By major hike, I mean doubling contributions at minimum. This will simply not happen: all announcements by the Ministry start out with the statement that “there will be no increase in costs or no loss of benefits to the insured.” Paparia.

But coming back to Greece’ debt: none of the measures announced by PASOK is a permanent measure. In their Stability and Growth Agreement, they are temporary measures. If we want to reduce the debt, we need the permanent reduction of public expenditure for at least 10 years, together with the long-term increase in revenues, to bring the debt down to manageable levels. (By manageable, I mean between 60-80% - the Maastricht criterion is 60%).

Otherwise, inflation and rising interest rates will very quickly eliminate whatever temporary benefit occurred. This is very simple arithmetic: anyone can do it.

If we add to this mix the fact that both major parties are essentially lying to the voters, or passing laws which make no sense whatsoever, then the situation does not fill me with much hope for the future. If Konstantinos Karamanlis did not make the right decisions with debt-to-GDP at 80%, a large majority, and the Olympic Games in 2004; and George Papandreou is not making the right decisions in 2010 with a debt-to-GDP forecast of 120% and being in the middle of an economic recession (with a larger majority); why would we expect the next administration, in 8 years, to do anything better?

We should instead plan for what is inevitable, rather than what we would like to happen: There will be a point in the next 3-5 years when Greece will not be able to pay its interest or loan instalments, and will default on debt, and demand a loan restructuring with its major creditors.

At this stage, the government will have to shut down operations. Salaries and pensions checks will be delayed; public sector workers will not be paid; there will be the inevitable major fall on the Athens Stock Exchange. And future borrowing will be all but impossible.

For a company like mine, which is based on providing due diligence and investment advisory services to foreign clients, the reputational impact will be disastrous. I'm already asked about Greek corruption and debt on every trip outside Greece. We have to bid against German and British companies for nearly all of our contracts. Up until now, we've had the benefit of the doubt: how long can this continue?

Our own corporate decision can no longer wait. I’ve said I would give PASOK the chance to publish it's 2010 budget and the Stability & Growth Agreement are before making a decision. Unfortunately, nothing in these documents gives me reason to believe things are going to improve.

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