Tuesday 22 November 2011

Political Credibility—and why it Matters

The demand by Eurozone countries that four key members of the Greek government—the Prime Minister, the Governor of the Central Bank, and the leaders of the two main political parties—issue a written letter of support for the October 26th Agreement may seem naïve, unless considered through a simple prism: no one trusts Greek politicians anymore.

In terms of logical reasoning, this may seem like a tautology. After all, we are all conditioned to certain truths, such as “all politicians are liars.” Yet on the strength of these liars, European taxpayers are being asked to spent a further EUR 100 billion for bailing out Greece, plus EUR 30 billion in direct “incentives” for their own banking systems as a consequence of the PSI haircut.

Whether we look at the Greek situation through the eyes of a banker or consultant working on a debt work-out, or a European politician working on the basis of “solidarity,” we would expect to see the following commitments undertaken by Greece:

a.    A clear working model of sovereign and corporate turn-around, which can be measured against objective indicators. The disbursement of additional loans or support is made conditional upon fulfilling this plan.

b.     The commitment of the political and economic class to implementing the plan.

c.     A specific schedule of implementation, with prioritisation on key actions, and slippages on minor points, but also exceeding the plan wherever possible.

Unfortunately, we see no such indicators wherever we look over the past two years:

·       The Papandreou government initially denied that there was a crisis. When it signed the first bail-out in May 2010, it continued to act in a largely partisan manner, reverting to traditional Greek patronage schemes and launching white-elephant projects which had little to do with either economic reality or sound business sense.

·     Worse than this, the government continued to make commitments to the Troika, but then never really implement them. Matters came to a head in September 2011, when Minister of Finance Evangelos Venizelos asked for a “political solution” to the fact that Greece wasn’t making its targets.

·       This was compounded by the disastrous proposal for a referendum on the October 26th agreement. This decision was made after the negotiations had already taken place, without prior consultation with Greece’s creditors.

This dismal performance has been compounded by a series of technical errors which should have been corrected from the outset, but which never were.

The first error is the fact that the initial bail-out package ignored the fact that not all Greek public debt had been consolidated. This meant that despite the initial restatement of debt made between November 2009 – April 2010, a second restatement followed in November 2010. This meant that Greece lost further credibility, and automatically placed the achievement of the 2010 targets in jeopardy. Yet numerous analysts—myself included—were well aware that not all debt had been consolidated. My post of June 26th, 2010 First Steps in Consolidating Greek Debt, is indicative. The impact this consolidation might have on Greece’s GDP numbers are explored in my September 10th, 2010 post, Some Progress, Major Problems Ahead.

The second error is the fact that the initial bail-out package listed in significant detail the revenue and expenditure impacts of public sector cuts and higher taxes, but it somehow failed to take into account the impact of higher interest costs, or the compound effect of interest. So while annual savings on the order of EUR 5-6 billion per year were being forecast, these were overshadowed by annual interest costs of at least EUR 15 billion.

The third error is that there has been absolutely no real prioritisation of measures taken. The Troika and the government appear to have gone into the austerity programme with a “big bang” economic restructuring in mind. Yet this failed to take into account the basic fact that PASOK, the ruling party, was never truly behind such a “big bang.” As a result, rather than prioritising the reforms that were truly important, the government has lost credibility through its failure to fully or adequately implement arguably minor priorities, such as the liberalisation of taxi licensing or pharmacies.

The fourth error is that there has not been an adequate communications effort to back the reforms. What reforms Greece did undertake in the first 2 years since October 2009 have been historic. However, they have not been adequately communicated either within Greece, or outside it. As a result, the Greek population sees austerity taking effect, but no real hope for an exit from the crisis, while the Eurozone creditors see a series of targets which have not been met (the failure of which they bear at least equal responsibility for), and equally, no visible signs of recovery.

These technical errors were then compounded by the classic political / operational issues so prevalent in Greece. The first and foremost of these is that no other Greek political party has taken its national responsibilities seriously. The ND opposition party has been against the first bail-out since its announcement, but has not provided a meaningful policy alternative. LAOS voted for the first bail-out, and since then has voted against every measure introduced by the government. The two (three) left wing parties (to the left of PASOK) appear to be living in a fantasyland of “worker solidarity” and, at one extreme, renationalisation of banks and hospitals.

Even when finally forced to work together, the Greek “home-made” solution is inadequate. It is absurd that a government of “national unity” will work for three months. No one realistically believes an unelected Prime Minister will be in power long enough to continue the reform programme. Everyone understands the risks of the political campaign scheduled to begin on January 20th, for elections on February 19th, and the hysteria and demagoguery this will unleash. And finally, no one understands how Mr. Antonis Samaras can claim to support the October 26th agreement, but not support new measures (or other measures).

Taking these errors into account, it is not surprising that European partners are insisting on a letter of guarantee for sticking to the reform programme in exchange for future funding. They are beset by their own internal political and economic situations; they are unaware of the real situation in Greece; they would probably do anything possible to avoid further financial guarantees to a country which has proven itself incapable of honest, effective governance.

The real irony is that even if Mr. Samaras finally signs a thousand letters, I very much doubt whether this will be enough. We are now in a situation where Greece’s poor internal performance has been overshadowed by a truly disastrous external situation. Absent a major political reform in the Eurozone, or a dramatic improvement in market confidence, we are heading for a European crash in days or weeks, not months.

Under the present political and economic conditions, it is therefore impossible to see how the second bail-out of EUR 130 billion will take place. This money can only be raised through an act of Parliament in 16 Eurozone countries, which agree to a further sovereign guarantee to raise loans on the open market. This is simply impossible now; it will be worse in January-February when they finally get around to voting.

These market conditions already make it impossible for the Eurozone countries to raise funds to bail out Greece, because (a) they will be fighting to raise money to refinance their own debt, and (b) it makes little economic sense for Spain or Italy to borrow at 6% and lend the money to Greece at 4%. With the French rating at risk, and the UK not participating in the Eurozone bailout, this means that four of the five largest European economies will not be in a position to raise money for the second bailout.

So many commentators have remarked that Europe needed at least EUR 2 trillion to properly combat the crisis. Yet this has been ignored in favour of small, incremental steps that are always behind the curve, and never complete. The fact that the EFSF is unable to raise the funding it needs quickly enough is indicative of the fundamental miscalculations made by European politicians, including the Greek ones, who have apparently believed they could use other people’s money forever.

Everything is now based on market sentiment, and on a European banking system which is rapidly showing signs of weakness, if not collapse. I am not counting on sentiment to recover any time soon.

© Philip Ammerman, 2011 

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