April 2010

Apocalypse later

To judge by the reaction in equity markets to last month’s agreement to bail out the ailing Greek economy from financial disaster, neutral observers might be forgiven for thinking that the crisis has passed. Had those observers reflected on subsequent developments in the bond markets, however, they would have drawn an altogether different conclusion: that the crisis is very much alive.

Despite EU assurances, and the explicit one-third participation of the IMF in any rescue package, the borrowing costs that Greece has had to pay to sell its bonds in the aftermath of the agreement are around twice that of Germany. These costs are high because investors remain fearful of the risk of a Greek default; their insistence on being compensated (in terms of higher yields) for assuming this risk implies that the probability of Greece avoiding default is far from assured.

Bond investors not only remain sceptical as to Greece’s ability to deflate its ballooning deficit, they are also wary of the EU’s willingness to help should Greece fail to do so. The fact that the IMF has been asked to join the rescue party has been interpreted in some quarters as reflecting EU weakness. There is also a suspicion that the EU/IMF agreement is as much politically expedient as it is economically desirable. Some observers (in reference to the originator of the suggestion to include the IMF, Germany) see a national political agenda taking precedence over economic necessity: mindful of important forthcoming regional elections, the German government needs to emphasise to the electorate that the German taxpayer will not be called upon to bail Greece out.

Beware of Greeks bearing gifts

The Greek government, meanwhile, has pledged to rein in its spending, sacrificing economic growth for financial stability. However, some analysts fears that the measures imposed so far, such as public-sector pay cuts and corporate tax increases, may yield savings that will only cover the extra borrowing costs incurred by sales of new debt. And, while their government is keen to publicly endorse these measures, the Greeks themselves clearly disagree. This could have political implications further ahead: economic austerity is an ideal breeding-ground for nationalistic demagogues who could conceivably be elected to power on a platform of non-abidance with the policies of the present regime.

Already now, Greek banks are being hit by outflows, as companies and wealthy individuals, in anticipation of further tax increases (especially if the IMF becomes involved), move their assets to international banks or offshore destinations. Should this trend accelerate, it will restrict the lending abilities of domestic institutions and exacerbate the already fragile Greek economy. Even equity investors will have to take note of that.