Monday, 21 May 2012

The Greek odyssey

Just like the legendary Greek warrior Achilles, at one point Greece seemed invulnerable: the country reported above the European average real GDP growth rates, relatively low budget deficits and stellar growth prospects. The figures ultimately proved deceitful: the budget deficit was adjusted to 12.5% of GDP in October 2009, in a time when the public debt was "only" 90% of GDP. It all went downhill from there.With credit spreads increasing, investors shunned Greek debt, prompting European banks to use cheap ECB credits to purchase more and more Greek bonds.

The Greek tragedy

Before the break-out of the financial crisis with its subsequent European contagion Greece boosted real GDP growth rates in excess of 4%, budget deficits of less than 3% and bond yields of 3.6% in 2005 and 4.1% in 2006, at least that is what the Greek Statistics Office reported. It was in October 2009 when it stunned financial markets by reporting that the budget deficit for 2009 was in fact 12.5 of gross GDP, instead of previously estimated 3.7% and admitted to having massaged country statistics in order to facilitate the country`s accession to the Euro area.

 This breach of confidence was the tipping point for the Balkan country: investors demanded higher and higher yields for the risk of holding Greek sovereign debt. Investment banks purchased distressed Greek bonds because they had access to cheap financing from the European LTRO programme and the FED USD swap lines, but eventually there came the time when financial institutions stopped thinking about the return on their capital and started worrying about their return of their capital. At this point no central bank stimulus, no cheap credits, no governmental benefits can entice investors to purchase sovereign debt. Greek public debt from Indexmundi:

Normally the so called "point of no return" is when public debt reaches 80% of GDP, but this was overlooked as yields on Greek bonds were very low before the outburst of the 2008 financial crisis. At public debt of 80% of GDP a country usually needs either to partially default through restructuring or inflation or to suffer austerity measures so that budget deficits add up less and less to the outstanding public debt. In the case of Greece, the government is planning to impose spending cuts of 1.5% of GDP (mainly from health spending), bank recapitalizations, privatizations of energy companies such as DEPA, DEFSA and Hellenic Petroleum, and labor reform (reducing the minimum wage which currently is 750EUR). Wage statistics from Eurostat:

Because the ECB effectively compensated the banks for buying distressed Greek debt by offering them LTRO cheap money, Europe indirectly monetised Greek debt. The saga ended in 2011 with a massive EU-IMF-World bank bail-out, followed in 2012 by a series of imposed haircuts (53.5% of the outstanding principal), triggering a credit event according to ISDA. These measures have bought some time for the troubled economy, but with public debt still at more than 100% of GDP, and ever increasing yields, bolder steps need to be taken.

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