ON my way back to Kuala Lumpur after attending Asia Vision 21: Values, Conflicts and Change in Asia organised by Harvard’s Asia Centre and Harvard Kennedy School’s Ash Centre, I could not help but feel sorry for the people of Greece given the predicament they are now in.
Greece’s problems are well known. My economics teacher Martin Feldstein had in late April judged Greece to be already insolvent and “at that point, will default”, or more politely, in negotiated default.
This can take many forms, including an “organised restructuring of the existing debt, swapping new debt with lower principal and interest for existing bonds.” That’s certainly one way to go where everyone (including creditors) shares the pain.
Over the February Chinese New Year holidays, the debt “death trap” that engulfed Greece was all over the place. In my Feb 27 column “The kiss of debt”, I discussed Greece’s dilemma and argued Greece might have been able to avoid the outcome if it were not in the Euro-zone and had its own currency, the drachma, back.
Greece was not alone in this. Together with the other Euro-zone PIIGS (Portugal, Italy, Ireland, Greece and Spain), these so called Club-Med members of the European Union (EU) share common traits: weak fiscal and debt positions, weak exports, weak balance of payments, and weak productivity (too high wages) caught in a zone with a strong euro, which made them all the more uncompetitive.
Desperate times, desperate measures
As I see it, they have only one way to go to restore competitiveness – fiscal retrenchment and structural reform. But the PIIGS don’t have a track record of fiscal discipline.
Greece, for example, lacks the economic governance of the EU and fiscal discipline of the Germans. Yet, it has to make the most of a weak hand at a 3-way poker involving the EU, capital markets and potential social unrest at home.
I then concluded: “In my view, they can best do this under an IMF (International Monetary Fund) programme and not in the shadow of the European Commission (EC) and the ECB (European Central Bank) without smelling like a bailout. The IMF gives them the best option to re-establish lost policy credibility.”
As events unfolded, I was in the “ballpark”. Many of the Euro-zone’s 16 member governments had opposed the IMF’s involvement because it reflected badly on the EU’s inability to resolve its own internal problems.
Early this week, the EU and IMF proposed a three-year 110bil euro (about 1/3 of Greece’s debt) deal that will extract huge sacrifices from the Greek people.
As I understand it, the IMF leads the rescue by providing 30bil euros, Germany 22bil euros, France 17bil euros, and the rest from the remaining 13 EU members.
In return, the bitter medicine for the Greeks will include: deep cuts in the fiscal deficit from 13.6% of gross domestic product (GDP) to EU limit of 3% by 2014, reduction in public debt topping at 150% of GDP in 2013 to 144% in 2014 and progressively lower thereafter, and stiff austerity with a combination of pay and budget cuts and tax increases.
The package needs EU approval this weekend. Essentially, the EU and IMF have given Greece only 12-18 months to show it can reform itself. Then, it’s back to the markets for more cash. This is tough by any standard. Especially when the package will bring about cumulatively 8% fall in GDP.
Greece’s problems are well known. My economics teacher Martin Feldstein had in late April judged Greece to be already insolvent and “at that point, will default”, or more politely, in negotiated default.
This can take many forms, including an “organised restructuring of the existing debt, swapping new debt with lower principal and interest for existing bonds.” That’s certainly one way to go where everyone (including creditors) shares the pain.
Over the February Chinese New Year holidays, the debt “death trap” that engulfed Greece was all over the place. In my Feb 27 column “The kiss of debt”, I discussed Greece’s dilemma and argued Greece might have been able to avoid the outcome if it were not in the Euro-zone and had its own currency, the drachma, back.
Greece was not alone in this. Together with the other Euro-zone PIIGS (Portugal, Italy, Ireland, Greece and Spain), these so called Club-Med members of the European Union (EU) share common traits: weak fiscal and debt positions, weak exports, weak balance of payments, and weak productivity (too high wages) caught in a zone with a strong euro, which made them all the more uncompetitive.
Desperate times, desperate measures
As I see it, they have only one way to go to restore competitiveness – fiscal retrenchment and structural reform. But the PIIGS don’t have a track record of fiscal discipline.
Greece, for example, lacks the economic governance of the EU and fiscal discipline of the Germans. Yet, it has to make the most of a weak hand at a 3-way poker involving the EU, capital markets and potential social unrest at home.
I then concluded: “In my view, they can best do this under an IMF (International Monetary Fund) programme and not in the shadow of the European Commission (EC) and the ECB (European Central Bank) without smelling like a bailout. The IMF gives them the best option to re-establish lost policy credibility.”
As events unfolded, I was in the “ballpark”. Many of the Euro-zone’s 16 member governments had opposed the IMF’s involvement because it reflected badly on the EU’s inability to resolve its own internal problems.
Early this week, the EU and IMF proposed a three-year 110bil euro (about 1/3 of Greece’s debt) deal that will extract huge sacrifices from the Greek people.
As I understand it, the IMF leads the rescue by providing 30bil euros, Germany 22bil euros, France 17bil euros, and the rest from the remaining 13 EU members.
In return, the bitter medicine for the Greeks will include: deep cuts in the fiscal deficit from 13.6% of gross domestic product (GDP) to EU limit of 3% by 2014, reduction in public debt topping at 150% of GDP in 2013 to 144% in 2014 and progressively lower thereafter, and stiff austerity with a combination of pay and budget cuts and tax increases.
The package needs EU approval this weekend. Essentially, the EU and IMF have given Greece only 12-18 months to show it can reform itself. Then, it’s back to the markets for more cash. This is tough by any standard. Especially when the package will bring about cumulatively 8% fall in GDP.
Debt jitters spread
As I had expected, the EU (especially France and Spain) is reported to have fought hard to keep the IMF out of the deal, but ended up endorsing a set of measures that bears IMF’s imprimatur.
This was deliberate; intended to persuade financial markets that Greece has a chance (I think, slim) of succeeding.
Nevertheless, market reaction since has been swift and severe across the board. On May 5, the US dollar strengthened to a 12-month high; the euro dropped to a one-year low (US$1.28). The euro depreciated close to 11% against the US dollar this year. As optimism over economic recovery in the US contrasted with doubts about successful resolution of the Greek debt crisis, sell-off in Asian equity accelerated in Europe and US.
European stocks tumbled to two-month lows, while bond markets of the weaker Euro-zone numbers fell as loss of confidence rattled investors across all asset classes.
Since May 4, the Dow fell 2½% and the FTSE Eurofirst 300 Index closed 3% lower, while Asian stocks were mostly lower, with the Shanghai Index down 2%.
The Vix SAP 500 Index (a gauge of expected equity market volatility) rose to 24-25, the highest one-day spike since October 2008. It continues to stay elevated, reflecting trading on event risk.
Overall, the Greek debacle casts a long shadow over market sentiment. Many risks still remain. Topmost is fear of contagion. Worry is centered on the other PIIGS, notably Portugal and Spain, since they may also need to be rescued.
I have seen estimates of the total size of a possible liquidity backstop for the PIIGS in the region of 500bil-1 trillion euros.
Bear in mind they are all facing interest rate increases at a time when they can least afford.
The private sector in many of these countries is simply not viable at rising higher rates. Last week, Spain joined Greece and Portugal in being downgraded by Standard & Poor’s, the credit rating agency. While Spain’s credit rating remains well above Greece’s junk status (BB+) and ahead of Portugal’s A-, its fall to AA was a severe blow.
After all, Spain’s budget deficit stands at 8.9% of GDP and Portugal, 7.6% in terms of public debt to GDP, Spain’s ratio is 60% and Portugal 82%.
My own sense is that it will not be easy for Spain and Portugal to avoid going to the IMF/EU for loans as they both have deteriorating public finances and rather weak economies. The only way out for them is to get international help early. It is now an issue of market psychology. I am convinced that if the EU (especially Germany) had sealed Greece’s deal in February, the rescue package would have been more cost effective.
Vicious cycle
By now, the vicious cycle at play should be familiar. First, the country’s financial situation deteriorates. Then, its debt is downgraded which in turn triggers off a sharp rise in market borrowing rates. That leads to further financial deterioration.
Second, the proposed package looks tight. The market estimates Greece will need at least 150bil euros to have a reasonable chance of success.
The only certainty so far is its ability to meet the 8.5bil euro bond payment in two weeks. To assume that Greece will do well enough by end-2011 to be able to borrow from the capital markets is too optimistic.
Bringing its budget deficit target down to 4.9% in 2013 will require about 50bil euros over three years.
In addition, past debt has to be serviced and Greece has another 70bil euros to repay by mid-2013. Thus, such financing already takes up 120bil euros.
There is simply no way around the arithmetic implied by the scale and urgency of the deficit reduction, debt servicing and the accompanying economic decline. I am not surprised the market is sceptical.
Third, fiscal consolidation is tough; without it, the pain inflicted could make the burden very painful. Burden sharing is critical. The political consequences should not be underestimated.
It is incredible that the rescue involves no hair-cuts and no restructuring. This package can be likened to what the IMF did to Latin America in the 1980s, which lead to a lost decade.
Without debt restructuring, the beneficiaries will be foreign creditors who get away fully paid (no hair-cut). The risks make it well-nigh impossible for Greece to return to the market for more loans later on.
Fourth, the package calls for very demanding austerity and sacrifice by the Greeks. Workers protests and strikes during the week reflect very real risks. As a result, markets are on a panic mode, draining bond markets of liquidity and forced-sales because of sovereign debt downgrades.
Unclear future
The climate of confidence has definitely changed for the worse. It is unclear whether the Greek government – facing angry unions and young workers – can push through and maintain the austerity steps it promised.
It is also unclear if the uncompetitive Greek economy, mired by recession still, can survive the sacrifices melted out while remaining in the Euro-zone. It remains unclear how the political tensions within and among the rich Euro-zone countries on handling the debt crisis will play out.
There is a sense that Germany in particular does not like any bailout. What is clear is the Greeks are ill-prepared for a long period of potentially back-breaking austerity, devoid of social justice. Without support of the public who are already outraged at corrupt politicians (whom they hold accountable for the crisis), the rescue is doomed to fail.
Why the mess? Most headlines in recent days were centered on Greece’s high debt as the villain – a profligate government who mismanaged the nation’s finances.
This is certainly part of the story. But the Greek tragedy has its roots in Greece being a member of the Euro-zone. Prior to the global recession, the state of Greece’s finances wasn’t so bad.
Its budget deficits and debt levels were high but manageable. It attracted its share of capital inflows on the belief that Greece’s bonds (as a member of the EU) were safe investments.
The 2007/2008 crisis changed all that. With easy money fast disappearing in the face of falling revenues and rising costs and a good life, Greece soon became uncompetitive and its economic situation worsened. As they say, the rest is history.
Unfortunately, as a member of the Euro-zone, Greece had to give up its own currency (and adopted the euro in its place) and control over interest rates. The only way out for Greece is to make drastic budget cuts (i.e. deflate) – which can be very painful – to become more competitive.
Unlike non-Euro nations, Greece could not adjust by depreciating its own exchange rate (since it doesn’t have its own currency anymore), and the euro (controlled by Germany) was not about to inflate.
Its finances became precarious. So much so its bonds were downgraded to junk status. This simply meant that the euro value of Greece’s GDP is unlikely to revert its 2008 level until 2017 according to S&P. Greece simply is unable to grow out of its troubles.
The concern is that the EU has no reliable financial mechanism to help members in trouble to adjust.
This is precisely what Euro-sceptics like Feldstein and Paul Krugman feared, bringing with it a crisis that can undermine the EU as a monetary union without political union.
Without its own currency, there is no market signal to warn Greece that its deficits and debt reached unacceptable levels. Euro-sceptics remain unconvinced that the EU’s problems are anything but over. Maybe, a real default is what is needed to test the EU as a viable political and economic union.
Lessons
The Greek tragedy should be instructive. For regionalists in Asia in a hurry to emulate the EU and push for monetary union – however loose – recent experience offers valuable lessons.
Among the necessary conditions are allowance for a crisis resolution mechanism, provision of effective fiscal policy co-ordination, and arrangements for a reliable mechanism to reduce intra-regional imbalances.
These point to the need for strong, disciplined support and ready access to sufficient funds to cushion off adjustments among problem members.
The endgame is obvious – avoid, at all costs, giving-up degrees of freedom you already have in policy adjustments, without sacrificing safeguards needed to protect national interests.
Governments need flexibility to act quickly and with clarity in times of crisis. Krugman is right on what he thought Greece did wrong in joining the EU: they denied themselves the ability to do some bad things (like printing money), but they also denied themselves the ability to respond flexibly to events.
WHAT ARE WE TO DO
Former banker Dr Lin is a Harvard-educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome at
starbizweek@thestar.com.my.
As I had expected, the EU (especially France and Spain) is reported to have fought hard to keep the IMF out of the deal, but ended up endorsing a set of measures that bears IMF’s imprimatur.
This was deliberate; intended to persuade financial markets that Greece has a chance (I think, slim) of succeeding.
Nevertheless, market reaction since has been swift and severe across the board. On May 5, the US dollar strengthened to a 12-month high; the euro dropped to a one-year low (US$1.28). The euro depreciated close to 11% against the US dollar this year. As optimism over economic recovery in the US contrasted with doubts about successful resolution of the Greek debt crisis, sell-off in Asian equity accelerated in Europe and US.
European stocks tumbled to two-month lows, while bond markets of the weaker Euro-zone numbers fell as loss of confidence rattled investors across all asset classes.
Since May 4, the Dow fell 2½% and the FTSE Eurofirst 300 Index closed 3% lower, while Asian stocks were mostly lower, with the Shanghai Index down 2%.
The Vix SAP 500 Index (a gauge of expected equity market volatility) rose to 24-25, the highest one-day spike since October 2008. It continues to stay elevated, reflecting trading on event risk.
Overall, the Greek debacle casts a long shadow over market sentiment. Many risks still remain. Topmost is fear of contagion. Worry is centered on the other PIIGS, notably Portugal and Spain, since they may also need to be rescued.
I have seen estimates of the total size of a possible liquidity backstop for the PIIGS in the region of 500bil-1 trillion euros.
Bear in mind they are all facing interest rate increases at a time when they can least afford.
The private sector in many of these countries is simply not viable at rising higher rates. Last week, Spain joined Greece and Portugal in being downgraded by Standard & Poor’s, the credit rating agency. While Spain’s credit rating remains well above Greece’s junk status (BB+) and ahead of Portugal’s A-, its fall to AA was a severe blow.
After all, Spain’s budget deficit stands at 8.9% of GDP and Portugal, 7.6% in terms of public debt to GDP, Spain’s ratio is 60% and Portugal 82%.
My own sense is that it will not be easy for Spain and Portugal to avoid going to the IMF/EU for loans as they both have deteriorating public finances and rather weak economies. The only way out for them is to get international help early. It is now an issue of market psychology. I am convinced that if the EU (especially Germany) had sealed Greece’s deal in February, the rescue package would have been more cost effective.
Vicious cycle
By now, the vicious cycle at play should be familiar. First, the country’s financial situation deteriorates. Then, its debt is downgraded which in turn triggers off a sharp rise in market borrowing rates. That leads to further financial deterioration.
Second, the proposed package looks tight. The market estimates Greece will need at least 150bil euros to have a reasonable chance of success.
The only certainty so far is its ability to meet the 8.5bil euro bond payment in two weeks. To assume that Greece will do well enough by end-2011 to be able to borrow from the capital markets is too optimistic.
Bringing its budget deficit target down to 4.9% in 2013 will require about 50bil euros over three years.
In addition, past debt has to be serviced and Greece has another 70bil euros to repay by mid-2013. Thus, such financing already takes up 120bil euros.
There is simply no way around the arithmetic implied by the scale and urgency of the deficit reduction, debt servicing and the accompanying economic decline. I am not surprised the market is sceptical.
Third, fiscal consolidation is tough; without it, the pain inflicted could make the burden very painful. Burden sharing is critical. The political consequences should not be underestimated.
It is incredible that the rescue involves no hair-cuts and no restructuring. This package can be likened to what the IMF did to Latin America in the 1980s, which lead to a lost decade.
Without debt restructuring, the beneficiaries will be foreign creditors who get away fully paid (no hair-cut). The risks make it well-nigh impossible for Greece to return to the market for more loans later on.
Fourth, the package calls for very demanding austerity and sacrifice by the Greeks. Workers protests and strikes during the week reflect very real risks. As a result, markets are on a panic mode, draining bond markets of liquidity and forced-sales because of sovereign debt downgrades.
Unclear future
The climate of confidence has definitely changed for the worse. It is unclear whether the Greek government – facing angry unions and young workers – can push through and maintain the austerity steps it promised.
It is also unclear if the uncompetitive Greek economy, mired by recession still, can survive the sacrifices melted out while remaining in the Euro-zone. It remains unclear how the political tensions within and among the rich Euro-zone countries on handling the debt crisis will play out.
There is a sense that Germany in particular does not like any bailout. What is clear is the Greeks are ill-prepared for a long period of potentially back-breaking austerity, devoid of social justice. Without support of the public who are already outraged at corrupt politicians (whom they hold accountable for the crisis), the rescue is doomed to fail.
Why the mess? Most headlines in recent days were centered on Greece’s high debt as the villain – a profligate government who mismanaged the nation’s finances.
This is certainly part of the story. But the Greek tragedy has its roots in Greece being a member of the Euro-zone. Prior to the global recession, the state of Greece’s finances wasn’t so bad.
Its budget deficits and debt levels were high but manageable. It attracted its share of capital inflows on the belief that Greece’s bonds (as a member of the EU) were safe investments.
The 2007/2008 crisis changed all that. With easy money fast disappearing in the face of falling revenues and rising costs and a good life, Greece soon became uncompetitive and its economic situation worsened. As they say, the rest is history.
Unfortunately, as a member of the Euro-zone, Greece had to give up its own currency (and adopted the euro in its place) and control over interest rates. The only way out for Greece is to make drastic budget cuts (i.e. deflate) – which can be very painful – to become more competitive.
Unlike non-Euro nations, Greece could not adjust by depreciating its own exchange rate (since it doesn’t have its own currency anymore), and the euro (controlled by Germany) was not about to inflate.
Its finances became precarious. So much so its bonds were downgraded to junk status. This simply meant that the euro value of Greece’s GDP is unlikely to revert its 2008 level until 2017 according to S&P. Greece simply is unable to grow out of its troubles.
The concern is that the EU has no reliable financial mechanism to help members in trouble to adjust.
This is precisely what Euro-sceptics like Feldstein and Paul Krugman feared, bringing with it a crisis that can undermine the EU as a monetary union without political union.
Without its own currency, there is no market signal to warn Greece that its deficits and debt reached unacceptable levels. Euro-sceptics remain unconvinced that the EU’s problems are anything but over. Maybe, a real default is what is needed to test the EU as a viable political and economic union.
Lessons
The Greek tragedy should be instructive. For regionalists in Asia in a hurry to emulate the EU and push for monetary union – however loose – recent experience offers valuable lessons.
Among the necessary conditions are allowance for a crisis resolution mechanism, provision of effective fiscal policy co-ordination, and arrangements for a reliable mechanism to reduce intra-regional imbalances.
These point to the need for strong, disciplined support and ready access to sufficient funds to cushion off adjustments among problem members.
The endgame is obvious – avoid, at all costs, giving-up degrees of freedom you already have in policy adjustments, without sacrificing safeguards needed to protect national interests.
Governments need flexibility to act quickly and with clarity in times of crisis. Krugman is right on what he thought Greece did wrong in joining the EU: they denied themselves the ability to do some bad things (like printing money), but they also denied themselves the ability to respond flexibly to events.
WHAT ARE WE TO DO
By TAN SRI LIN SEE-YAN
Former banker Dr Lin is a Harvard-educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome at starbizweek@thestar.com.my.
We have several instruments at our disposal and we will use them 
