Thursday 22 July 2010

The Greek Bail-out Package and the Future Political Risks of Debt Restructuring

Greece’s elected government—and by extension all Greek citizens—face a tremendous moral dilemma which may not have been fully thought out. The IMF/Eurozone bail-out package of EUR 110 bln over three years has been, we learned in Kathimerini yesterday, accompanied by ECB purchases of Greek bonds to a total of EUR 44 bln. The ECB has purchased these bonds primarily from private banks: previous articles have stated that French banks have been at the forefront of Greek bond sellers.

Greece’s debt at the end of 2009 stood at EUR 298 bln, versus a GDP of EUR 237 bln. By the end of 2010, we can assume that total debt under the best case scenario will have risen by at least EUR 36 bln to EUR 331 bln as follows:

·         EUR 6 bln healthcare settlement
·         EUR 10 bln OSE debt assumption
·         EUR 2 bln other public organisations, guaranteed by the government
·         EUR 15 bln government deficit (assumption)

Taking into account a forecast -5% GDP decline (my estimate), Greece’s GDP will be EUR 225 bln, and its debt:GDP ratio will be 147%.

By 2012, when the bail-out package is set to expire, I estimate that in the best case, the public sector debt will have reached EUR 368 bln, or 165% of GDP. My estimate does not specifically include the interest cost of the debt, which I have no way of modeling given the opacity of public statistics on Greece’s debt portfolio.

Assuming the ECB purchases no further Greek bonds, the Eurozone governments, the IMF and the ECB will have purchased a total of EUR 154 bln of Greek sovereign debt, to which they will have senior rights.

This means that 48% of Greece’s total debt in 2012 will be held by the Eurozone, the IMF and the ECB.

And this is the problem: before the bail-out package was agreed, Greece could have defaulted on its debt, which was overwhelmingly held by private sector banks. This would have been painful, but it is a fairly routine affair.

From 2012 and afterwards, 48% of the debt will be held by sovereign partners or multilateral institutions. Will Greece really be able to restructure debt or impose a bond “haircut” on Germany or France?

What happens the day after that occurs?

It is clear to me that Greece is caught in a debt spiral. The absence of any decisive action by the government on issues such as OSE or even the healthcare debt settlement are indicative of the problem.

Minister of Infrastructure and Public Transport Dimitris Reppas, for example, yesterday stated that he would not accept layoffs at OSE, the Hellenic Railways Organisation:

Should no solution be found, sources claim that Brussels has even spoken of layoffs in order to reduce workers, although Infrastructure, Transport and Networks Minister Dimitris Reppas stressed yesterday he would not accept layoffs at OSE and ministry sources made it clear that the organization’s chief would not stay in his post if he were to witness OSE employees being laid off.

This is pure political theatre. There will not be a real “solution” to OSE–or any other loss-making Greek governmental organisation–as long as half-measures like this are taken.

On the healthcare settlement, although a minimum 15% haircut on the settlement (amounting to a debt restructuring) is expected, the government never made an attempt to figure out which contracts should be honoured, and which contracts should be investigated for corrupt practice: all contracts were honoured at face value. This rewards the corrupt, while punishing the honest.

This same half-hearted approach is visible all across the government. It is seen in the ridiculous attempt to solve the “cabotage” issue with quantitative restrictions reminiscent of 1970s dirigisme. It is seen in the government’s attempt to extend liquidity to Greece’s banks, and then require them to use that liquidity to buy government bonds, or extend loans to government organisations. It is seen in the incomprehensible decision to prop-up companies in the textiles or fertilizers sector which should have gone bankrupt a long time ago.

Absent bold, radical action to close loss-making government organisations, downsize the public sector, and free the private sector from the absurd tangle of regulations which are largely meaningless in their supposed utility, there will not be an exit from the debt trap we are in. Neither major political party has come forward with a coherent vision or policy programme to address this.

My advice is: prepare for the worse-case scenario to materialise. The clock is ticking. The scale of the problem is clear; the end-date in the best case is late 2012 or early 2013: it may come sooner than we think if the bond yields on recent issues are any guide. 

Wednesday 21 July 2010

The OSE Saga Continues

Landon Thomas, writing in the New York Times (Greek Rail System’s Debt adds to Economic Woes) on June 20th, has just published an excellent and highly cogent analysis of the financial and operating problems faced by OSE, the Hellenic Railways Organisation.

Among the points mentioned in this article:

·         The government has agreed to the Troika request to add OSE’s debt to the Central Government balance. This means that approximately $ 13 bln will be added to Greece’s debt this year from OSE alone.

·         Drivers on some routes are moving near-empty trains on mountain routes at a salary of $ 130,000 per year.

·         There have been $ 3.2 bln in investments on rail track and infrastructure since 1997.

·         OSE’s personnel numbers some 7,000. Between 2000 and 2009, OSE’s payroll rose by 50% while total headcount fell by 30%.

I’ve written about OSE several times in past posts (see list below). Today, I think we should all recognise that the government’s stated plans of privatisation of 49% and cessation of management control are simply not going to work. This is a half-measure, which no potential investor is going to accept given the militancy of Greece’s unions, the fickle nature of the Greek government’s promises, and the basic economics of rail travel in Greece.

What is needed is far more drastic therapy:

·         OSE should be immediately broken up into inter-regional and urban operating companies. Major cities, like Athens and (in the future, Thessaloniki) should have their own companies. A PPP partnership, such as the Athens Metro, could be one bidder for the assets in Athens.

·         Inter-city lines, like Athens-Thessaloniki, or Athens-Patras, should be continued only on the basis of an objective business plan and due diligence by an external company like Deutsche Bahn or SNCF.

·         Regional lines, like those in the Peloponnese or northern Greece, should also be reviewed by the consultants, but it is highly likely that these need to be stopped entirely.

In each case, the objective is to transfer assets, less liabilities, to the operating companies, which should be fully privatised within a period of 12 months. All privatisations should occur through televised, transparent auctions.

Any entity can bid: for instance, if the city of Drama, which recently protested the announced closure of its rail link, wants to bid, it should be able to. But it has to be established that the central government will not allocate any further funding to any other public or private organisation for railway operation or investment.

Any operating entity not purchased at auction should be liquidated and the assets transferred to the Public Property Management Organisation for sale. Any proceeds should be earmarked to pay down central government debt.

Any employees currently working for OSE lose their right to continuation of public sector employment. The new operating companies will be able to offer certain members a position, at private sector rates. The remaining employees can receive a standard unemployment insurance, or potentially retirement.

This is the only realistic option to solving the problem. Inner-city rail travel is economically possible; only a few inter-city routes have the potential for profitability; most regional lines have to close.

There is no further time to lose, and no further funds to invest in the maintenance of a public sector behemoth of this type.

Related Links

Tuesday 20 July 2010

Sokratis Giolas and Greece Today

Yesterday another shocking death, that of journalist Sokratis Giolas, broke on an unsuspecting public. Mr. Giolas was executed outside his home by at least two people, apparently wearing bulletproof vests and police uniforms. At least 16 cartridges were found at the scene: he was finished off with three shots to the head.

Giolas’ death adds to the increasing list of meaningless deaths suffered as a result of political violence or terrorism so far this year (and there are probably more incidents not on this list):

·         On March 29th, a 15-year old Afghan immigrant was killed by a bomb outside the offices of the Hellenic Management Association. The boy was rooting through garbage for food or items to trade—his mother and sister were injured in the attack.

·         On May 5th, three employees of Marfin Bank, one a pregnant mother, were killed in a Molotov bomb attach on their branch at Stadiou Street.  

·         On June 24th, a letter bomb exploded in the offices of the Ministry of Citizens Protection, killing a 50-year old police officer.

The international press have carried the story widely. In parallel, a furor has sprung up on the blogosphere and social media as to why this particular journalist would have been the target of a terrorist organisation known as the “Sect of Revolutionaries”, or whether this was some form of political assassination. Mr. Giolas is reported to have been a founder/ contributor of the troktiko blog, which carried a range of stories, some sensationalist, some not, on corruption and conspiracies in Greece.

I have no opinion to express here of Mr. Giolas or his reporting. I can only hesitate to think what could have been so terribly secret that he would have been assassinated: after all, there are great crimes occurring in Greece in broad daylight.

But beyond any kind of attempt to rationalise the event, as I’ve been trying to do since yesterday, there is simply a feeling of emptiness and sorrow. Sorrow that Greece has come to this. And emptiness, because it seems the only way one can inure oneself from the downward spiral that has become an everyday reality is to ignore it.

More and more, life in Greece is resembling something from a Don Dellilo novel I read a long time ago, The Names. In this case, I suppose that nothing has really changed. For anyone who has not read it, I strongly recommend it.

Monday 19 July 2010

Debt at any Cost?

One of my main professional scope of activities has to do with debt issue, whether through the preparation of due diligence or business plans, for both borrowers and lenders. So it’s with a great deal of skepticism that I read in Kathimerini that the government was satisfied with its latest round of debt issue.

Last week, the Public Debt Management Agency raised a 26-week bond for EUR 1.625 bln at a rate of 4.65%. The issue was oversubscribed by 3.64 times. About 80% of the issue was subscribed by banks in Greece. This has been heralded as a success by the PDMA Director, Petros Christodoulou:

We are happy with the composition of the investor base and participation,” …. “Starting from the very short end of the market, this is a thumbs-up for the fiscal policy that has been implemented.'”

Finance Minister George Papaconstantinou told reporters in Brussels:

“We are satisfied” … “The year 2011 will be a good one to come back to the market, assuming conditions continue to normalize.”

Although I can understand the very real need for regaining market confidence, I have several major reservations about this issue:

1.      The 6-month rate of 4.65% is exhorbitant. Assuming this debt is not covered by the EUR 110 bln bail-out package, and assuming it won’t be repaid from the regular state budget 6 months from now, it means that the effective annual rate is 9.3%. This is hardly something to be proud of: it shows more than ever that Greek debt is still toxic on world markets.

2.      The fact that 80% of the issue was raised from Greek banks is hardly surprising. This rate is far better than any other investments they will make in the next 6 months in the domestic household or corporate sector. I wonder, however, to what share of the EUR 10 bln granted to “improve liquidity” in the Greek banking sector from the EUR 110 bln bailout has been used by Greek banks to buy Greek government bonds?

This appears to be very much a simple “recycling” operation: the Greek government borrows money at 5% from the IMF and the ECB/Eurozone. The Government passes $ 10 bln (at 5%) onto Greek banks for recapitalisation. The banks then lend part of this money at a 9.3% effective annual rate to the government, making what everyone hopes will be a quick return to keep the Greek debt circus on the road.

Of course, there are also apparently no other short-term options. The EUR 1.625 bln is not covered by the EUR 110 bln bail-out. The government has no other sources of ready cash to refinance the bond. The government does need to re-establish confidence in Greek debt issues on world markets, even if it has to buy this confidence with absurdly high rates. Yet the public statements appear so far removed from the reality that anyone with a rudimentary knowledge of finance feels increasingly uncertain as to the future. If this level of refinancing continues, it is highly unlikely that Greek will be able to emerge from its debt trap. 

Together with Piraeus Bank’s offer for government shares in Agricultural Bank of Greece and the Hellenic Post Bank at what amounts to fire-sale prices, I wonder what other “sacrifices” or deals will soon be made. 

Friday 16 July 2010

Reflections on the Present

It’s been nearly two weeks since my last post: I’ve been travelling and working in New York and now Orlando, and this evening briefly logged onto the Cyprus Mail and the Kyiv Post to keep track of news in two of the other countries where I work. The news is nearly universally bad.

In Cyprus, it appears highly likely that the reunification negotiations will be coming to an end, and that one potential exit scenario will be direct trade for the Turkish Cypriots and trade with Turkey for the Republic. It would appear that all the effort of the past two years have been for naught, and that the occupation and division of Cyprus will continue, although very few people—except for a small political and business elite—appear to benefit from it.

It would also appear that there is not just one division of Cyprus—between Greek and Turkish Cypriots—but in fact multiple ones. In the Republic, for instance, the governing coalition is divided against itself, while the right is divided from the left. The political elite is divided from the real world. The business oligarchy is divided against the ordinary citizenry. And the public sector is divided against everyone else.

In Ukraine, President Yanukovich celebrated his 60th birthday with a monumental party, amid reports that his plans to strengthen the power of the Presidency and consolidate his ruling coalition’s power are proceeding apace. One gets the impression, reading the Kyiv Post, that Ukraine is barely holding on to the precious economic gains it has made since independence, and is busy relinquishing most of the political ones. The oligarchical class that dominates Ukraine’s banking and heavy industry is consolidating its political power, and there doesn’t appear to be any political force capable of supplanting it, or offering an alternative.

Reading the wider news on Bloomberg or the Financial Times, if you look very closely, you will see that to some extent, we all seem to be living in Paris in the summer of 1939.

In the United States, mid-term elections are coming up, and an ugly sense of malaise embitters the country and its airwaves. One chapter of the Iowa Tea Party posted a billboard showing Barack Obama between Adolph Hitler and Vladimir Lenin. Negative political advertising dominates the Florida TV channels here, blaring between the imprecations of trial lawyers seeking clients or the latest miracle drug.

Unemployment remains high, the toxic debate over immigration is reaching a tipping point, and the economic recovery may be affecting some business sectors, but not much of it seems to be trickling down to the vast underclass that works the all-you-can-eat buffets or washes the hotel laundry here in the Disney universe. America’s mood seems to be changing: from relentless optimism to vitriolic negativity.

Having been in the United States for nearly two weeks now, the virtues of the life we lead in Greece seem all the more pronounced. To some extent, we live in a banana republic, but I can’t say that the quality of law-making and elected administration here in the United States is terribly different.

Greek debt-to-GDP is probably around 130-140% of GDP as I write this, but the US if following close behind. This year, USA Today forecasts an FY 2010 deficit of $ 1.5 trillion, marginally down from $ 1.6 trillion last year. If you add federal, state, local, Social Security and semi-governmental debt in the US (Fannie Mae, Freddie Mac), it’s probably higher than Greek government debt.

In Greece, Siemens appears to have bought much of the Greek government for a bargain rate of EUR 100 mln. In the United States, the 2008 Presidential election cost over $ 1 bln, while various special interest groups spent over $ 500 mln lobbying against healthcare reform in the past 12 month.

And in Greece, we still have a human scale of life. I was struck once again – as I am each time I visit the United States – of the rootlessness of this place. I was born in Athens, and for all I dislike what that city has become, consider myself an Athenian. There are places in Greece where I know I am home, and which I can never forget.

An American can be born in Salt Lake City, move any number of times in his life, and then settle in some sterile housing park in Florida, without thinking anything is amiss. I can’t imagine living in a suburban Floridian development–each one similar to the other–and shopping for plastic food at WalMart.

Besides that connection to our birthplace, I believe that for all its faults, Greeks are also still cognizant of the sacrifices made by past generations so that the present ones can live in a makeshift democracy. Although Greece too is sinking beneath the weight of mindless consumerism and the idiocracy of morning TV, there are still enough people who remember. For how much longer, I’m not certain.

And yet, as bad as things are in the United States or Greece, they are infinitely worse elsewhere. I don’t think many of us truly know how fortunate we are, especially when compared with the average citizen of Russia, China, or countless other countries.

This is what more than anything gives me the feeling that, all short-term economic signals to the contrary, we are sliding to the brink of the proverbial cliff. It seems that public officials or citizens in the United States and Greece are incapable of taking the difficult decisions needed today in order to survive the challenges of tomorrow. And these challenges are upon us.

What comes next? 

Monday 5 July 2010

Greek Pharma Debt Restructuring hits International Press

The international financial press is starting to pick up on the fact that the restructuring of Greek government debt has begun. On June 19th, I reported on this blog that, based on the agreement reached by the government and the pharmaceutical suppliers to the public healthcare system, a restructuring of at least 15% was planned for those debts settled using Greek government bonds.

Yesterday, John Dizard wrote in the Financial Times (“It’s no secret: Greece is restructuring debt”) about this same agreement. He references a joint Press Release by the Ministry of Health and Social Welfare, and the Ministry of Finance, which states that:

“In case suppliers settle these bonds by January 2, 2011, it is estimated that the total cash received would be close to EUR 6 billion”. The above “discounts” corresponds to a total percentage of about 19%”

Dizard writes further that, according to his research

And while the release says the debts “will be settled”, major suppliers have not yet agreed to the hospital debt bloodletting. According to a London dealer in edgier emerging market paper, some of the suppliers have already been around to get a bid. Unsuccessfully, sad to say, even though the suppliers’ banks have that promise of “ECB” repo availability. He sniffs: “You won’t get a bid at 50 [per cent of face]. My guessing is that it is more like 30. We were appalled at the very low quality of the documentation.”

In other words, unless a pharmaceutical supplier is determined to hold on to a bond until its term is due, selling this onward will bring less than 50% its actual value.

For those interested, press reports are beginning to emerge that the Ministry of Finance is considering a similar settlement for debts owed to construction firms. 

Saturday 3 July 2010

Greek Government reforms Pick up Speed

The reforms undertaken by the PASOK government some 9 months into its first term under Prime Minister George Papandreou are impressive. Although the government got off to a late start, and although it took a massive funding crisis to start the process, we should not underestimate the magnitude of the changes already passed, or under consideration.

Some indicative points I take with me as I leave for the United States tomorrow:

a. Greece is undertaking its first systematic inventory of employees in the public sector. Although this is difficult to believe, the exact number is unknown. In a next step, the conditions of employment in the public sector will gradually be harmonised.

b. Greece is undertaking its first comprehensive reform of the public and private sector pension systems, using actuarial forecasts and modern accounting principles. In contrast with previous efforts, this effort is being done with a full(er) accounting of liabilities and life expectancies than at any time previously. The principle of equal work and retirement conditions for male and female workers, and for workers in the public and private sectors, is at the heart of the pension reform effort. This is attracting major opposition from special interests which may bring about the downfall of the government. For the sake of Greece’s financial survival, the government must succeed. (The alternative to this reform would be to raise pension contributions and link these to incomes, which few taxpayers understand).

c. Greece is making a first serious attempt to measure and reduce its vast public sector debt. Initiatives underway, such as the resolution of medical sector debts (EUR 7 bln), construction debts (EUR 9.5 bln) and efforts to reduce the unrestricted expenditure of public sector organisations such as OSE (apparently EUR 11 bln debt) are gradually taking effect.

d. Greece is taking steps to reduce its operating costs and public investment budget. This includes a permanent component, which will come through the merger of local administrations and public sector units and a hiring freeze, as well as a temporary component, which includes salary cuts, cuts in overtime and extra compensation, and other reductions.

e. Tax reform has been announced and to a large extent implemented. Large numbers of independent, self-employed professionals such as accountants, lawyers and architects no longer pay a lump-sum annual tax irrespective of annual earnings. These professions are also being drawn into the VAT regime for the first time.

f. Greece is starting to cut down on tax evasion. Audits among doctors, public officials, offshore companies, and domestic companies are increasing and important cases of income tax evasion are being referred to the courts.

The government still needs to make progress in a number of important areas:

Public Sector Corruption
To date, there have been no substantial penalties for any public figures implicated in corruption scandals. A few cases such as former Defence Minister Akis Tsochatzopoulos, or former Transport Minister Tassos Mantelis, are under investigation. It remains to be seen whether these individuals will actually pay financial restitution for their crimes, or whether these incidents too will be somehow written off.

Public Sector Inefficiency & Corruption
The government needs to move to replace and prosecute members of the Hellenic Tax Authority, the Hellenic Customs Service, the Ministry of Health and the various hospitals which report to it, and a wide range of other organisations for continuing corruption and dereliction of duty. This will be difficult given the current conjuncture of events, but it is necessary.

Private Sector Tax Evasion
More needs to be done to combat tax evasion in the private sector. Initiatives which should be undertaken include a full inventory of Greek owners (nominal or nominee) of Cypriot offshore companies as well as a full investigation into asset ownership in Greece.

Public Sector Crisis Management and ROI
The government needs to develop a formal crisis management plan designed to restore the country to solvency and growth. This should be modelled on a private sector turn-around plan. Any and all government projects, whether in terms of investments or operating costs or policies, should be evaluated in terms of cost-benefit analysis and return-on-investment. Any non-essential expenditure should be cut.

Real Privatisation and Deregulation
Public sector monopolies in energy production and distribution, renewable energy, fixed-line telecommunications, transport, education, healthcare and nearly every other business sector continue to exist. A determined effort should be made to liberalise these sectors while regulating all players within each sector in a meaningful way. Some companies, such as OSE, should be broken up and liquidated or privatised, or a mix of both. The government has already started this process, and I was pleased to learn that loss-making rail lines are being discontinued or scaled back.

Development of Business Clusters and Vertical Policies
Rather than relying on growth through subsidies, the government should, in conjunction with the private sector, select a number of business sectors to develop vertical, export-oriented clusters. As surprising as it sounds, Greece does not have an industrial, export or investment promotion policy which is oriented on specific products or clusters. There is also no link between its policies for investment in education and infrastructure, with income-generating sectors or projects.

Examples of such clusters include agriculture, where too many products are exported in a whole fresh or IQF form, or the automotive sector, where Greece has almost no domestic production of any significant components or parts. Instead of scattering subsidies among thousands of small businesses, the government should address the needs of a vertical value chain expressed as primary production – processing – retail/export – supply chain. Greece needs to change the state-led mentality of “subsidies for the people”, which has resulted in far too many uncompetitive and under-capitalised micro-enterprises which are not commercially viable, and also in far too much corruption. Greece needs to invest in future industries (e.g. ICT and energy) rather than sunset industries (e.g. cotton cultivation).

Administrative Reform
Greece remains a country dominated by redundant administrative procedures which detract from efficiency and turn away foreign and domestic investment. The e-government initiatives started should be accelerated, and certain functions, such as investment approval, housing approvals, etc. should be placed online in the form of a “one-stop shop”, which includes licensing and regulation. This should be an urgent priority.

Investment Promotion
“Real” investment promotion must occur, driven not by subsidies, but by the reduction of administration and pointless procedures, tax incentives and credit guarantees. This should not be oriented solely on mega-projects which take years to materialise, but on small-scale projects as well.

My main concerns at this point in the process are the following:

a. Opaque Statistics
There is still too much uncertainty regarding the true magnitude of Greek debt, the true scale of public sector income and expenditure, and the debt payment schedule. Greece needs to publish, on a single A4 sheet of paper, its total liabilities, the impact of the various reforms being undertaken, and how this relates to its debt repayment schedule, e.g. from 2008 – 2020. Only then will investors have any degree of visibility over Greece’s fiscal position.

b. Ministerial Competence
Some ministers, such as Finance Minister George Papaconstantinou, are doing a stellar job. Others are practically non-existent, or sabotaging the wider government reform efforts. The Prime Minister should, after the passage of the pension reform bill next week, restructure his cabinet. This could include bringing in high-level ministers from outside the PASOK party environment. There are a whole suite of Deputy Ministers who have been selected on the basis of popularity and are doing practically nothing in their appointed jobs. Certain Ministries should be split and decentralised.

c. Propaganda
Related to this, the current practice of trying to “talk up” the economy should be ended. Recent statements by Minister of Tourism Pavlos Geroulanou on the decline of incoming tourist arrivals, or Alpha Bank President Yannis Costopoulos on the size of the 2010 GDP fall, are transparent boosterism, and give the impression that these officials do not understand what is happening in Greece today. It would be better to accept that Greece’s recession will be much more painful than predicted and that this will last into 2011. Greece will need to practice austerity for at least 10 years to work out even 15% of its actual debt burden.

d. Public Opinion
Unfortunately, the wider public understands neither the necessity of the reforms, nor their real impact. Acceptance of reform measures is minimal, and a feedback cycle is exerting itself in Parliament among members of PASOK. This endangers the party majority, and thus the government of Greece. It is hard to blame the public for its fury: the large majority of citizens have been minding their own business while a political and business elite have plundered the country. PASOK needs to explain what it is doing, and why. It should do this with numbers and information, not shouting matches on television windows. The level of misinformation is incredible; the quality of communication abysmal.

e. Punishment
If reforms are to be accepted and implemented, the government needs to actually punish the thousands of individuals and companies in the public and private sectors who have looted the country. This has to be done in a meaningful way, including asset seizure and imprisonment. To expel Akis Tsochatzopoulos from PASOK pending his investigation is not a sufficient act (although the legal investigation is theoretically underway). If dockworkers block a commercial port in contravention of the law, they should be arrested and prosecuted. The Siemens and Skaramanga and Vatopedi corruption cases should be investigated by the courts and legal action taken. These are simple, self-evident decisions which are taking far too long to implement.

f. Financial Sufficiency
My final doubt is whether all this will be enough. Measuring the added financial costs of debt service over the next three years adds up to more than the preliminary savings announced by the current reform plan. It is highly probably that absent an economic recovery (which no one expects), Greece will have to extend the bailout for at least another 3 years, and possibly restructure some debt (probably in the form of an interest freeze, or a lower interest rate). The restructuring of the debt for domestic creditors—notably construction firms and pharmaceutical suppliers—has already started.

Foreign analysts and observers have been quite concerned as to whether the government will be able to implement these reforms, or whether:

• The government will lose its parliamentary majority and fall, or
• Whether the country will dissolve into armed anarchy.

Either one of these options is possible, although the second option would probably not last long if it did occur. What is clear, is that there does not appear to be any alternative among the Greek political parties. New Democracy is clearly trapped in its own illusions and the morass of its past corruption. None of the smaller parties have a credible economic platform or the leaders needed to handle the crisis.

Many people therefore find themselves in the position I find myself: cross your fingers, and hope Papandreou succeeds. The reforms need time to take effect, and political upheaval at the present time is not in anyone’s interest. There is simply no alternative, since about 50% of Greece’s official debt is now in the hands of other Eurozone countries and institutions. I estimate that about 40-45% of the difficult decisions are behind us, but at least the process has started. Will it be enough?

Friday 2 July 2010

EIB pours more money down the Greek Railway Drain

I was hit by a powerful sense of unreality in reading today’s announcement that the European Investment Bank allocated a EUR 2 bln loan for Greece, of which EUR 1 bln will be spent on rail investment. This including upgrading the Patras-Athens-Thessaloniki-Promahonas line, developing a railway node at Acharnes, a freight complex at Thriassio and a rail link to the Neo Ikonio Container Terminal at Pireaus.

It should be mentioned that OSE, the Hellenic Railways Organisation, has a debt of over EUR 9 bln. Its 2008 turnover of EUR 195 mln was far outstripped by its operating loss of EUR 794 bln.

I have not seen an investment plan, business plan or turn-around plan for OSE. The government claims it wants to sell 49% of the business, including the management, to a strategic investor. Unless the government takes over the debt, and backs the potential investor to reduce and replace staff, I fail to see who could possibly be interested, or how such a partial privatisation could work.

The fact that the government has recently been asked by the Troika to take OSE’s debt directly onto its balance sheet, rather than treating OSE like a special-purpose vehicle, only worsens Greece’s fiscal situation.

Unless this investment somehow translates into a major demand for passenger and cargo traffic between Pireaus, Patras and Thessaloniki, I do not see how it can possibly be justified on economic grounds:

· The high debt of OSE means that adding a further EUR 1 bln, for an investment project that will take at least 3 years to complete, and then will not easily result in a direct return on investment, simply seems irresponsible at this point in Greece’s development.

· If Greece is to take on more debt, it should target an annual ROI of at least 10-15% within the first 2-3 years. This means that the debt can be serviced quickly, the project can be implemented quickly, and the investment adds to national income, not national debt.

· Greece has not mastered multimodal transport hubs, and neither Pireaus nor Patras appear well-suited for such a hub involving a rail-road-port nexus. The fact that the major ports, with the exception of part of the Pireaus cargo terminal, are controlled by militant unions or unproductive state monopolies means that any development in these areas will be slow, expensive and uncertain.

· The terrain of Greece and the unstable geology along the northern shore of the Corinthian Gulf and the eastern coast of continental Greece means extremely high costs and technical risks, as well as recurring costs due to high maintenance and engineering costs.

· The presence of a national highway which is currently being upgraded, and the relatively short distances between the three cities, means that road transport is very competitive against rail. What alternative returns would have been gained by simply expanding the road network, or investing in road transport, which is in fact the objective of the 2 PPP contracts? Why split the potential ROI between two competing transport forms, and invest in double infrastructure (road and rail) along both routes?

I am also continually wondering why Greek and the EIB do not examine and back alternative, more productive investments?

· A EUR 1 bln investment in Patras, Corinth or alternate locations on the Corinthian Gulf, to create and integrated cargo and high speed ferries port as well as bonded warehouses, commercial zones and manufacturing sites similar to the Jebel Ali Free Trade Zone. Such an industrial, trade and transport hub would be much easier to reach from Athens, and can link directly to the Corinth-Athens-Thessaloniki national highways (which are already being upgraded through 2 PPP partnerships).

· A EUR 1 bln investment into Thessaloniki airport, creating a Balkan transport and cargo hub for the rapidly-growing Balkan countries plus Turkey, would enable Greece to compete against the regional hubs of Istanbul, Vienna and Munich. This would link into the Egnatia road, and hopefully into a modern port complex, which is sorely needed in northern Greece.

· A EUR 1 bln investment in renewable energy would bring far higher returns to Greece, both in terms of offsetting carbon emissions (for which Greece will soon be paying a financial penalty) as well as in terms of improving the trade deficit. Rather than importing oil at $ 80/bbl (or burning our high-sulfur coal), we would generate carbon-free energy.

· A EUR 1 bln investment in modern, large-scale agriculture using geothermal energy and modern greenhouse technology (which requires almost no pesticides or chemicals) would create a new export sector, improve the trade balance, and create many places of employment. Each 100,000 m2 unit costs about EUR 20 mln, employs around 45 people, produces about 15 tonnes fruits and vegetables per day, and generates annual sales of about EUR 7-9 mln. This would literally revolutionise high-value agriculture in Greece, which could then be further valorised by investing in processing.

· A EUR 1 bln investment in a high-technology IT and energy incubator for entrepreneurs of any nationality who wanted to set up in Greece would lead to potentially world-class technologies which could transform the country in ways we cannot begin to imagine. While such an investment would have to be managed by several established sectoral VC firms operating under contract (of the caliber of Accel Partners, 3i, Kleiner Perkins, etc), this would show more than anything else that Greece is investing in the future, rather than in the hoary past of loss-making railway lines.

Instead, Greece continues to allocate scarce financial resources to a sector which is operated by a state-owned monopoly with impossibly high fixed costs and no competitive future. We expect OSE’s annual losses to continue, and see now way in which it’s debt can be repaid. Rather than privatising OSE, we should be liquidating large parts of it, and channeling any further financial resources into sectors with a greater future viability, far beyond the dead hand of the Greek state.

Related Links

First Steps in Consolidating Greek Debt: OSE/OASA

Thinking about Government II: The Role of OSE