Tuesday 27 November 2012

Eurogroup achieves compromise on Greece; definition of “debt sustainability” highly unlikely

After weeks of wrangling over Greece’s debt sustainability, the Eurogroup approved a compromise agreement last night under which:

·       The notion of debt sustainability was re-defined between the IMF and the Eurozone, enabling both parties to save face and the IMF to keep lending (which it is legally prevented from doing if its own analysis indicates that a debt is unsustainable).

·       The long-awaited tranches agreed in the first and second bail-outs will be disbursed as soon as Eurozone member states approve the deal. The total amount is EUR 43.7 billion, of which EUR 23.8 bln is EFSF bonds for bank recapitalisation and EUR 10.6 bln for budget financing (most of which involves public debt refinancing).

·       Minor tinkering in loan terms, including a 10 year maturity extension, a 100 basis point interest rate reduction on the Eurozone component of the loans, and a 10 bp EFSF interest rate reduction. Member States are “committed” to returning ECB profits to Greece from the ECB’s secondary market operations.

·       Greece is also given an additional 2 years to meet fiscal targets, which was a key campaign demand of Antonis Samaras, the Greek Prime Minister.

Unfortunately, none of these “deal” components are sufficient to solve the actual problem:

a.     Under the plan, Greece’s debt will continue to rise – to at least 190% of GDP – before hypothetically falling to 175% of GDP in 2016 and 124% of GDP in 2020.

b.     Given this fact, it is impossible to see how foreign (or domestic) investment and privatisation will be attracted to Greece, enabling a real economic recovery to take place. As such, it is highly questionable to believe that growth targets can be met.

c.     A 100 bps interest rate reduction on the Greek Loan Facility, while welcome, is insufficient to assure a substantial reduction of debt. The GLF amounts to EUR 73 billion disbursed from May 2010 – December 2011, and while I do not have a precise current interest rate amount (these are bilateral loans), if we assume a reduction from 4% to 3%, the total saving is on the order of EUR 803 mln—probably less. This saving is less than 8% of Greece’s budgeted annual interest costs (EUR 10 billion), and about 5% of what I calculate actual interest costs are (EUR 14 billion).

d.     Extending the debt maturity, while temporarily removing future repayment risks, continues to accrue interest, and therefore debt. Allowing Greece a further 2 years to meet fiscal targets continues to accrue interest and therefore debt.

e.     There was no decision on using EFSF funds to implement an open-market buyback. The comment in the communiqué that “Greece is considering certain debt reduction measures in the near future, which may involve public debt tender purchases of the various categories of sovereign obligations” is disingenuous, to say the least, given that Greece does not have the financial resources to do so, and in any case is prevented by the bail-out agreements from doing so: all extra revenue is earmarked for Troika debt service.

Viewed from a political perspective, I can well imagine that the rationale for this decision was something to the extent that “We’ve done what we can – Greece must do the rest.” There is much truth in this statement.

Yet to the reality-based perspective, all this is too little, too late to make much of a real difference. What appears to be a deliberate obfustication of the facts only casts suspicions that European policymakers are out of touch with financial reality. This carries a grave cost in terms of market confidence, and a grave risk in terms of contagion effects on other Eurozone countries.

I reflect briefly on the events of the past few years. Mr. Antonis Samaras served as leader of the New Democracy opposition party from early 2010 to June 2012. Apart from a brief stint where ND participated in the Papademos interim government (from November 2011 – April 2012), he has been virulently opposed the austerity measures which he has just passed in order to assure this latest instalment of the “never-ending Greek bailout”.

Today he returns from Brussels, heralding a “victory” in the negotiations, and trying to make the most politically from this. Yet in a recent poll, SYRIZA leads polling by 22.3% (voter intentions), followed by ND with 20.1%, Chryssi Avgi with 10.3%, and PASOK with 7.5%. Other polls put SYRIZA and Chryssi Avgi 2 points higher.    

To paraphrase the political perspective mentioned earlier: the ball is indeed in Greece’s court. But this is precisely where it has been since the October 2009 elections, and beforehand.

Absent a real restructuring of the public sector and a real growth strategy, the latest Greek bail-out will fail to make any meaningful impact on either economic growth or employment. The root causes of this are unchanged:

1.     A dysfunctional political oligarchy which is literally driving the country to ruin for political and financial gain;

2.     Endemic corruption, a tragicomic justice system and an underperforming education system which exacerbate the other trends;

3.    A lack of international competitiveness or competitive advantage in every economic field;

4.     A global financial and manufacturing economy which makes traditional policy remedies (import taxes, capital controls, devaluation) impossible;

5.     Repeated attempts to solve a public debt crisis by adding more debt.

If Greece continues to look for European assistance to solve its debt crisis and its underlying economic uncompetitiveness, it will fail. Indeed, in the dual dependency culture it has developed, it already resembles many highly indebted African countries that have suffered so much throughout the 1970s and 1980s.

Regrettably, I see no signs of any real policy initiatives necessary on the scale of addressing these five root causes. I expect continuing political fragmentation, and I do not believe the current government will last beyond May or June or 2013.

As such, I see few signs of a sustainable solution ahead.

© Philip Ammerman, 2012

Philip Ammerman is Managing Partner of Navigator Consulting Group and European Consulting Network. The opinions expressed in this post are his own. 

Saturday 24 November 2012

Demography and Equity Performance

The Financial Times has published an interesting analysis on the linkages between demographic growth and stock market performance in today’s Weekend edition (The Population Conundrum)

Research quoted in the article makes a convincing case that

The 1982-1999 bull market was driven by the post-war baby boom, which resulted in a bulge in the numbers of working-age adults and the core savings group. … Those adults are now retiring, having spent too much time working and not enough time procreating.

Falling birth rates and rising life expectancy have left the industrialised world with a demographic profile very different from that of the 1950s. There is a growing body of evidence to suggest that sharply ageing populations will weigh on both economic growth and asset values for years, if not decades to come.

Although the data refers primarily to the United Kingdom and the United States, we have seen similar evidence to this in other countries. In Greece, for instance, an equity boom occurred from the mid 1990s to 2007. 

Precisely this experience indicates that while demography may have been a factor, there are a number of other factors at work:

a. In the United States, the Individual Retirement Account (IRA) was introduced in 1986. Over time, this had a snowball effect as professional fund managers increasingly channelled this capital into equity markets. It would be interesting to compare stock market performance between countries with IRA-style individual defined-contribution systems with those (such as most continental European countries) where such schemes do not exist.

b. The Soviet Union collapsed in 1989. Starting at this point, there was a moment when Russian, Chinese and Indian competition (and domestic capital) simply did not exist. The opportunity for Western companies such as Kraft, Nestle, Procter & Gamble, McDonalds, RJR Tobacco, Carrefour, Walmart, Caterpillar, Volkswagen, Hochtief, Michelin and others was simply unprecedented. Things are obviously much more difficult now, as the hyper-growth seen in most segments is the former Soviet Union is now over, while Chinese and Indian market conditions are very different. This had a massive impact on US and UK listed company performance.

c. Floating formerly state-owned enterprises on stock exchanges became a major policy priority for governments across the world from the 1980s and onward. Privatisation and listing became a core part of the “Washington consensus”, and was an important part of World Bank, IMF and EU policy initiatives as well as a critical policy for national governments. In addition, general stock market listings became fashionable, with the New York Stock Exchange and the London Stock Exchange becoming magnets for listings not only from the US and UK, but though ADRs and listings of foreign companies, including the dot.com cohort.  Furthermore, the lack of sufficiently deep capital markets in many other countries created an import of capital to the US and UK to invest in their listed companies—yet another example of too much money chasing too few opportunities.

Demography is absolutely critical in many respects. But in this respect, I believe that these other factors account for the higher price/earnings ratios quoted in the article. There was significant capital mobilised for trading, including margin accounts and other unsecured loans for equity purchases, to assure a high P/E.

Having said this, I would not minimise the upside of the demographic shift from Baby Boomers to Generation X. The resulting inheritances will no doubt save many a struggling Generation X household, and the taxes upon this inheritance will save many a government budget, at least in the short term. 

In the longer term, the fundamental questions posed on pension sustainability remain absolutely correct. And, in most countries, absolutely unaddressed.

© Philip Ammerman, 2012

Philip Ammerman is Managing Partner of Navigator Consulting Group and European Consulting Network. His comments are made here in a personal capacity.