The 6th tranche of Greece’s Economic Adjustment Programme (EAP), which was initiated in May 2010, is due to be paid to Greece by the end of September (€8bn). The European Commission is busy compiling its Fifth Review of Greece in order to ascertain how much progress Greece has made in meeting its ongoing financial and economic objectives.
Clearly the financial markets are extremely concerned that Greece will be judged to have not sufficiently met its stated fiscal objectives and therefore not be allocated the 6th tranche of the EAP. Under those circumstances Greece would most likely default. At the same time, the implementation of the 21 July 2011 support package for Greece it taking a long time, especially the potential Debt Swap agreement.
This uncertainty has led to a very significant re-pricing of Greek assets in the financial markets. In fact, it can be argued that the financial markets are signalling a 80% to 90% probability of a default in Greece. The Greek 5-year CDS is well over 3500bps (which is possibly the highest in the world), the 2-year bond yield is over 70% and the 10-year yield is over 20%.
During the past year, the world financial markets have focused on the increased risk of Greece defaulting, as well as the implications of a default for the Euro-area. However, in the background, the Greek economy has suffered extreme hardship and remains in a deep recession. From its peak in Q3 2008, the Greek economy has declined by a total of more than 10%, real. The latest GDP data for Q2 2011 shows a decline of 7.3%y/y and the economy is on-track to fall by a total 5% in 2011. The unemployment rate is above 16%, and rising. Clearly the situation is dire.
The following comments highlight some of the extreme weaknesses in the Greek economy:
- Economic sentiment (confidence) has been decimated in the past two years and remains close to its record low.
- The rate of unemployment has risen sharply from around 8% in 2008 to over 16% currently.
- Retail sales have fallen by an average of 12.5%y/y in the first half of 2011, after declining sharply in 2009 and 2010.
- Industrial production has fallen on an annual basis in each of the past 39 month.
- New car registrations are down 34.2%y/y.
- Tourism levels have plunged.
- The VAT rate has been increased to 23%.
- House prices have fallen for the past 2 years and in Q1 2011 recorded an annual decline of 5.7%y/y.
- The stock market has lost 84% of its value since peaking in late 2007.
- The value of government bonds have plunged dramatically in the past 18 months, with yield on the 2-year government bond now over 70%.
- The dramatic fall in equity and bond market prices suggest that the value of pension and long-term retirement savings have been decimated.
- Greek citizens have withdrawn a significant portion of their deposits from Greek banks, presumably to either transfer to banks outside of Greece or to utilise the funds to supplement their monthly income.
- Greek banks have had to dramatically increase their borrowing from the Euro-system.
- The deficit on the Greek State Budget for the eight months Jan to Aug 2011 amounted to €18,1 billion. This compares with €14.8 billion during the same period in 2010.
- Net government revenues amounted to €30.7 billion in the period Jan to Aug 2011, falling 5.3%y/y, mainly as a result of the severe recession.
- Government expenditure has risen by 8.1%y/y during the period Jan to Aug 2011, partly driven by increased unemployment benefits and grants to social security funds.
To-date, the Greek government has not reduced its workforce, but is under enormous pressure to reduce employment and expenditure. Unfortunately, the need for increased austerity has contributed to the deep recession and therefore a strain on tax revenue. The lack of tax revenue has meant a lack of improvement in the government’s financial position and therefore the need for more austerity. A reinforcing downward spiral has been created, with no obvious solution.
Hopefully the 21 July 2011 debt swap agreement gains support, together with an eventual increase in the financial stability facility and other support measures. Without the support of Germany, however, the Greek government is facing an inevitable default.
Should Greece default, it will be important to ascertain as quickly as possible the nature of the default. It is critical that any default it managed well and that it does not become disorderly (run on the banks, capital flight etc), as that could be catastrophic for the country.
It will also be important to judge if the default is accompanied by an exit from the Euro-area. Under current circumstances, an exit from the Euro-area would probably also be catastrophic given how reliant the Greek banks have become on obtaining funding from the rest of the Euro-system. We will continue to closely monitor the situation.
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