Will She....Won't She? The Greek Government's "Latin Tango" With The IMF

Well the wires are really alive this morning. Greece is receiving a visit from the IMF today. The meeting was scheduled well in advance, but that doesn't mean the agenda was.

A team of International Monetary Fund officials arrive in Greece today to aid the government in its efforts to tame Europe’s biggest budget deficit. The mission, “within the context of the regular surveillance that the IMF provides to its membership,” will help the government with “pension reform, tax policy, tax administration and budget management,” a spokeswoman for the Washington-based lender said in an e-mailed statement yesterday.

Really we have what is know as a "fluid" situation right now, and no one seems to be very clear about what happens next. The IMF arrive in the wake of an Athens visit by EU and European Central Bank officials last week (to discuss the government’s plan to be submitted to the EU before the end of the month), and EU President Herman van Rompuy is also scheduled to visit today. It is hard to know what the outcome of last week's visit was, but press reports speak of the delegation pushing Greece to adopt tougher measures to cut the fiscal deficit.

It is however very important to understand that the issue in Greece is not simply one of reducing public spending to rein-in the deficit. The underlying problem is the external deficit (15% of GDP current account deficit) and the distortions in the economy and loss of competitiveness that this reflects. Simply cutting the fiscal deficit without addressing these issues will not reduce the government debt to GDP ratio, and may well actually increase it. It is the sustainability of Greek finances in the longer term that is the issue, and the only way of putting government finances back on a sustainable path is to return growth to the economy, and the only way to do that is to carry out an internal devaluation.

This is one of the principle reasons that I personally am arguing of the the IMF to take Greece into its arms now. Basically, I fear the Greek government itself is far from convinced of the necessity for the measures it needs to take, and a government which is itself not convinced will prove incapable of convincing a citizenry who still remain substantially in the dark about why what is about to happen needs to happen. The IMF is the only institution which I can see available at this point to oversee the process with the firmness which will be needed.

Olli Rehn Fails To Convince

What is required of Europe's leaders at this point in time is some clear speaking, and this is exactly what we are not receiving. Asked by the Catalan MEP Ramon Tremosa (CDC) during his confirmation hearing yesterday whether he intended to put in place the kind of mechanism which IMF European Director Marek Belka has been calling for Rehn fought shy of an outright commitment to direct means of compulsion, and suggested that the desired result could be achieved by using “incentives” to encourage states which found themselves in difficulty to move toward compliance adding that there was a need for “broader surveillance”. But he did pledge to use “all instruments” to help member states restore their finances and come into compliance with the terms of the stability and growth pact, so I imagine that we are still talking about a "fluid situation" whose actual significance will only become clearer at the February EU summit. It could simply be that in order to get the 2020 plan consensually agreed Olli Rehn is putting the emphasis on incentives rather than coercion, but it must be evident that the means of coercion must be there if needed, and this must be clear to all, and in particular to the electors who vote-in those otherwise wavering politicians.

Certainly Spain's leader José Luis Zapatero hasn't made things easy for Rehn, as he seems to have bungled matters yet one more time in the present case, and his proposal that the EU should adopt "biting economic safeguards" only met with a full frontal rebuttal from German Economy Minister Rainer Brüderle, who on being interviewed stated he was opposed to what he described as plans by the Spanish EU Presidency to "sanction" member states who do not comply with the European Union's "growth objectives".

Basically this confusion is all Zapatero's fault, since he presented the proposals as a move to set binding economic goals for member states under the coming 10-year plan to boost growth and competiveness, and called for corrective measures for those that do not comply. The 2020 strategy is intended to replace an earlier plan (the Lisbon aganda) that has manifestly failed in its goal of making the EU the world's most competitive economy by 2010.

"It's absolutely necessary for the 2020 strategy [...] to take on a new nature, a binding nature," Zapatero told reporters in Madrid one week after Spain began its six-month EU presidency, a mainly organisational role in which it can influence policy. He made clear he had not secured the agreement of other member states to make the economic goals binding under the 2020 strategy, but called for such proposals to be discussed at an economic summit in Brussels next month. "The informal summit on 11 February must bring up, in my opinion, measures including incentives and corrective measures for objectives set out in our economic policy," he said. "European competitiveness depends on two words - unity and competitiveness. European unity and a competitive economy."

All of this is really a complete confusion. The "binding measures" are need to reinforce the Excess Deficit Procedure which is applied under the Stability and Growth pact, and to give the right to the Commission to oversee the necessary structural reforms and internal devaluations. They are not needed to police growth targets which may or may not be realistic. No wonder the German economy minister got irritated. These measures are likely to be used against Spain, not Germany, and the growth issue only arises in the context of enforcing the SGP, since for those countries who enter a negative debt dynamic, a return to growth is essential, if default is not to be come inevitable.

Greece Is Not Argentina, Yet

Moving now from the ridiculous to the even more ridiculous, Desmond Lachman has an article in the Financial Times this morning entitled Greece looks set to go the way of Argentina.

"....much like Argentina a decade ago, Greece is approaching the final stages of its currency arrangement. There is every prospect that within two to three years, after much official money is thrown its way, Greece's euro membership will end with a bang."

This is nonsense, at least at this point. At this moment in time no country is either near, or even remotely near leaving the Eurozone, and I'll tell you why. If Greece's Eurozone membership ends with a pop (or even a whimper) that wouldn't be anywhere near the end of the matter, since Spain would come hurtling right along behind, producing in the process the largest external debt default in recorded history, and the most likely aftermath would be that the whole Eurozone would end with a bang (with totally unknown consequences for the global financial system). So, quite simply, we cannot let that happen. Greece would not be Argentina (which was, after all the shouting, a mere financial pinprick). Greece could potentially be a much more serious matter than Argentina ever was.

I repeat, the issue is internal devaluation, and enforcing it. And if we can't do it in the Greek case the markets would be quite entitled to draw the conclusion that we won't be able to do it in the Spanish one.

The basic problem is returning the key countries to a sustainable growth path. As Standard & Poor's stated when they took their recent decision to lower their ratings outlook on Spain, the reason for the change was the probability that the country will see "significantly lower" gross domestic product growth and "persistently high fiscal deficits relative to peers over the medium term".

Personally I find nothing especially exaggerated in this judgement. S&P's preoccupations seem valid, and widely shared, among others by the technical staff who prepare forecasts for the European Commission. The issue is not that Greece and Spain are on the verge of default, but that it would be dangerous to allow the situation in these two countries to deteriorate further. Reducing the level of external debt has to be one of the top priorities for both the Greek and the Spanish administrations, and it is clear that the only way to do this is by exporting more, importing less, and running a trade surplus. This is what the whole issue of restoring price competitiveness is all about, and since Spain no longer has the means to carry out a conventional devaluation the technique known as internal devaluation is the only one presently on the table and able to do the work in the time available.


So the immediate issue is not the inability of Greece and Spain to repay their external debt, but the fact that anti-crisis measures that simply have the effect of pushing up both the external debt to GDP ratio and the government debt to GDP one are hardly a helpful contribution. Both countries need to correct their external imbalances, not increase them further. What the Greek and Spanish governments need to apply are not policies which simply allow their countries to limp along from one year to the next, but reform measures which help them straighten out all the distortions which have accumulated during the course of the property bubble.


Obviously it would be proposterous to compare Spain's fiscal situation with that of Greece, and indeed I know no one who has actually suggested that this is the situation. The concern being expressed is not that Spanish finances are on the verge of bankruptcy, but rather that the level of government debt to GDP is rising very rapidly, and that unless growth is restored to the economy the sustainability of public finances will become a problem in the longer term. According to the most recent EU Commission forecast Spanish gross government debt to GDP is set to rise from 39.7% in 2008 to 74% in 2011.

The situation with unemployment and job creation is similar. José Luis Zapatero has at long last publicly recognised that Spanish unemployment will only start to fall in 2010 (and not 2009 as previously forecast). The only problem with this is that outside Spain no one seems to recognise this seemingly good news, since the EU Commission and the IMF both maintain their forecasts for no improvement in unemployment in 2010 or 2011. In fact the forecasts for growth in GDP are still so low for 2011 (1% in the best of circumstances) that it will obviously be impossible to create increased aggregate employment if there is even a minimum level of productivity improvement.

Let us be clear then: the number one topic facing the Spanish government is how to restore growth to the economy. All the policy measures applied up to now have evidently failed to achieve this end. And now, following pressure the European Union to change course, Spain is going to have to increase taxes and reducing spending, while interest rates are likely to start to rise slowly. Far from adding momentum to the economy, all of these developments will simply serve to reinforce the recession, driving the level of GDP further and further downwards, and of course debt to GDP levels further and further upwards.

Evidently the Spanish situation is not yet as severe as the Greek one is. But risks abound. In the first place, and as Olli Rehn says, what happens to Greece is vital importance to Spain.

“The problem in Greece concerning the excessive deficit and rapidly rising debt is a very serious one,” Rehn said. “It has also potential spill-over effects for the whole euro zone.”

But risks to Spain are also accumulating inside the country itself, in particular in the form of the large stock of unsold houses the banks effectively are taking onto their balance sheets, houses whose value are effectively an unknown quantity. There are an estimated one and a half million new properties in Spain awaiting a buyer. Some of them are on bank balance sheets after being accepted in debt for property swaps. But far, far more are indirectly on their balance sheet via loans to property developers which will eventually be defaulted on. Many of these loans are continuing to be restructured, with developers generally now unable to afford even the interest payments, which are tending to get "rolled over".

And now a new threat is looming: the rising rate of repossesions that the banks will need to accept in 2010. According to a recent article in the Spanish daily Publico - as reported by Spain Property Insight's Mark Stucklin - Spain's banks will have to cope with between a further 100,000 and 150,000 repossessions which are likely to come to a head in 2010. Many of these foreclosures started as far back as 2008, but have been delayed by overloaded courts unable to process the avalanche of repossession demands. From now on these foreclosures will be the “biggest problem for the banks” according to one real estate professional quoted in the article.

And the situation has become even more complicated, since the banks now find it very difficult to take such properties to auction, for the simple reason that the people who are normally there to buy them - the subasteros - are unable to get the credit from the banks that they normally use to buy with.

As Mark points out:

The big question is what impact this new batch of repossession – the equivalent of 15% to 20% of the current inventory of property for sale – will have on the market. Unable to sell at auction, the banks might end up offering them for sale at their write-off values. The danger is that an avalanche of these properties dumped on the market at write off values will send the market into a spin, with prices falling another 20% to 30%.

So, my final point is, we should not take the idea that the Eurozone is not about to fall apart as a reason for being complacent. Risks abound, and are painfully evident. And what we now need from Europe's leaders is action, more action, and yet more action to establish clearly in everyone's mind that they are aware of the task in hand, and are up to the job of carrying it through.