Monday, 22 August 2011

Continued Risks in the Greek Reform Programme

The risks in the Hellenic Republic’s Medium-Term Fiscal Consolidation Programme (MFCP) continue to mount. Despite the short-term easing following the passage of the two MFCP laws on July 21st and 22nd, 2011, there is growing evidence that the national and international situation may not contribute to the expected solution. Unfortunately, all this has been covered before in this blog, but a short summary follows here:

a. The reform programme continues to lag in the absence of bold, headline reforms or a coherent, cost-benefit approach to reforms. The EUR 50 bln privatisation plan has not yet begun. This is both due to declining values on the Athens Stock Exchange and the Greek economy in general, as well as due to a lack of preparation and credibility at the government level.

b. The recession in Greece is becoming wider and deeper—as has widely been expected and commented in this blog and by many other observers. In addition to a potential GDP revision for 2010, I anticipate a minimum recession of 5% in 2011 and a rise in unemployment to 18% not taking into account the active labour market measured by OAED (which is currently subsidising over 300,000 labour positions while paying unemployment insurance on at least 650,000 more).

c. The international economic environment continues to decline. Second quarter growth in France and Germany has, as expected, slowed to near zero. Contagion has spread to Italy and other Eurozone countries. Indicators such as container shipping prices and shipping company profits show growing volatility in the face of fluctuating demand and sectoral overcapacity. A number of indicators in China, including commodity price inflation, inflation and trade volumes, indicate an extremely uncertain situation. (The picture is not uniformly negative or positive, but the volatility and uncertainty given this stage in the presumed economic cycle is very worrying).

d. I believe there is a strong chance that one or more Eurozone parliaments will refuse to ratify the second Greek bail-out package, pointing to the lack of constitutionality in expanding the European Financial Stability Fund (EFSF) or to the lack of progress on the first bail-out package. Already, four countries are demanding specific guarantees in exchange for further loans. I widely expect premature national elections in one northern European country, with Germany a strong candidate, over parliamentary deadlock over the bail-out.

e. Key aspects of the second bail-out package remain unresolved, including the expansion of EFSF powers (subject to parliamentary approval in many countries) as well as the basic problem that interest costs have not been adequately reduced.

This international uncertainty and the lack of a coherent national plan conceal many useful reform measures that have been taken in Greece. Examples including the expansion of retirement age, the proposed streamlining of government units, the reduction in public sector headcount, changes to income tax levels, etc. But most of these remain insufficient in their scope, and are not enough to offset the main problem, which is the lack of effectiveness in the public sector, the high debt interest costs, the lack of political will in implementing reforms, and the continued corruption in the public sector (and among political parties).

Adding donor fatigue and a worsening international economic environment, and I believe it is clear that the true crisis point has not yet been reached.

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