European Affairs

This visit, a courageous one, as many Greeks revile Merkel and Germany for, in their view, having imposed the austerity that caused a historic economic depression of 21 straight quarters of declining GDP and a national unemployment rate 27.6% - (58% for under25-year olds.) But this draconian cure for budgetary excesses, huge deficits and debt, was, in fact, prescribed by the “Troika” of the European Commission (EC), strongly backed by Germany; the European Central Bank (ECB) and the IMF. Painful as it was, austerity did produce results positive enough to enable Greece to borrow again.

Government spending dropped dramatically (Fig. 1), causing the budget deficit to improve sharply (Fig. 2), enough so that the primary budget balance (excluding interest on the national debt) was in surplus; and the huge debt-to-GDP ratio has started to decline (Fig. 3).

Fig. 1 – Greek Government Spending (€ billions)




Fig. 2 – Greek Government Deficits (% of GDP)



Fig. 3 – Greek Government Debt (% of GDP)


Austerity paid other dividends as well, notably the dramatic decline in 10-year Greek government bond yields from a high of 48.6% in March 2012 to only 6.26% on April 17 – (See Fig. 4). (The spike in Greek government borrowing costs between 2009 and 2013 occurred after an extraordinary decade when markets managed to ignore Greece’s profligate borrowing and spending excesses; the country rarely paid more than 1% more than Germany did to borrow for ten years!) Other good news: The Athens stock market index is recovering, albeit from a very depressed level (Fig. 5).


Fig. 4 – Greek Government Bond Yields (10-year)


Fig. 5 – Greek Stock Market – (Athens Stock Exchange Index)


Other positive signs encouraged the government, and its bank advisors, to return to the market. The record high unemployment is forcing wages and salaries down, making Greek labor costs more competitive. From an all-time index high of 122.9 91 Index Points in the fourth quarter of 2009 (Fig. 6), the index was down to 91.0 by mid-2013 and is estimated to have fallen further by the yearend.


Fig. 6 – Greek Labor Costs (Eurostat Index)


Greece’s improving competiveness is also showing up in its current account balance (trade in goods and services), which showed a surplus in 2013, the first since the Bank of Greece began reporting C/A data in 1948. This is a remarkable turnaround from the record deficit of 18% of GDP in 2008 and 7.7% of GDP in 2012. (See Fig. 7.) Plunging consumption and investment caused a 4.5% drop in imports last year. Tourism improved sharply, boosting export revenues 2.3%. Countries with a C/A surplus usually have strong exports based on the cost competitiveness and export quality, whereas those with chronic C/A deficits typically have strong imports, low saving rates and excess consumption relative to disposable income.


Fig. 7 – Greek Current Account Balance 2003-2012 (% of GDP)



As Greek labor costs moderate and international competitiveness improves, business confidence is picking up significantly, as shown in Fig. 8. Business Confidence, as reported by the European Commission based on a survey of 410 Greek companies, rose to 97.50 in March 2014 from a low of 74.80 in March 2009. The EC’s Business Climate Indicator focuses on production trends in recent months, export order books, inventories and production expectations.


Fig. 8 – Greek Business Confidence



Remarkably, even consumer confidence is improving, albeit from a very low level, as Fig. 9 illustrates. The Economic Sentiment Indicator index, as reported by the EC, rose to “only” -59.70 in March 2014 from a record low of -83.80 in October 2011. The index measures 1500 households’ optimism about the economy and financial situation, as well as intentions to buy durable goods.


Fig. 9 – Greek Consumer Economic Sentiment Indicator


The Larger Picture …. And Questions

But has Greece really turned the corner to become credit-worthy enough to merit investor confidence over the medium term? Or is its apparently successful bond deal also a signal that international markets are so desperate for yield, thanks to determinedly easy monetary policy imposed by the ECB, the Federal Reserve and other central banks, that they are willing to gamble again that Greece is no longer a sovereign credit risk?

In fact, investors buying the Greek paper may have been persuaded more by the Troika’s s continuing supervision of Greece’s budgetary and economic performance. Equally important for international investors has been Euro-zone governments’ response to the crisis since 2009, meaning the numerous institutional mechanisms put into place to guard against a new debt, budgetary or payments crisis.[2] One very important factor is the new Single Supervisory Mechanism (SSM, a new system of financial supervision for Euro-zone banks), led by the ECB and national regulatory authorities, including those using the euro and those cooperating close with the SSM. The ECB’s new banking supervision responsibilities begin in November, although it is already conducting stress tests on the 130 largest Euro-zone banks.

The latest example of institutional protection of the Euro-zone’s financial structure (and investors in Greece) was the European Parliament’s April 15 approval of legislation needed for the European Union’s (EU) ambitious banking union project. The measures included a bank recovery and resolution directive setting out the rules to deal with a failing bank and oblige bondholders and shareholders to accept up to 8% of the bank’s total liabilities. Another directive defines the Single Resolution Mechanism in a way that requires owners and creditors of major Euro-zone banks pay first (rather than taxpayers), as well as establishes a €55 billion fund to cover the costs of closing a bank, a fund to be financed over eight years by all Euro-zone banks. Also confirmed was a deposit guarantee program for deposits of up to €100,000, a plan to be funded by Euro-zone countries and the banks. National deposit guarantees had been put into doubt by the Cyprus crisis.

Perhaps the most important single factor comforting investors in the Greek bonds, however, is the ECB’s implied guarantee to back Euro-zone bank assets and sovereign debt. In addition to ECB President Mario Draghi’s pledge in 2012 to “do whatever it takes” to save the euro, he said on April 12 at the IMF meeting in Washington that “the strengthening of the exchange rate requires further monetary stimulus.” Markets think he means that the ECB could start “quantitative easing” of monetary policy. If the ECB emulates the Fed’s QE, then it may start buying government bonds on the secondary market, thereby respecting the letter, if not the spirit, of its charter (which forbids the ECB from buying sovereign debt directly from Euro governments). Buying government bonds on the secondary market would prop up the value of Greece’s new five-year securities. Alternatively, the ECB could reduce its refinancing rate from the current 0.25%; implement a negative deposit rate; or stop sterilizing excess liquidity from its asset-purchase program.

Any of these measures would re-enforce the ECB’s implicit role as a buyer-of-the-last-resort for financial investors, including those financial or non-financial entities, or individuals, who bought Greek debt. Today’s canny but yield-starved investor is thus confident that Euro-zone governments, rather than risk another crisis threatening the euro, will go a long way to protect the system, hence their investments.

There remains, however, an important underlying risk: Greece and its citizens’ willingness to endure further joblessness and declining living standards. Current economic indicators are not, in our view, very promising, especially over a five-year term. The country’s credit system is still deleveraging, which means the private sector is starved for credit as shown in Fig. 10. Loans to private sector averaged €23.4 billion annually from 2002 to 2014, peaking at €36.4 billion January 2009, then collapsing to a record low of €14.1 billion in February 2014. There are few signs that the banking system will boost lending soon.


Fig. 10 – Greek Bank Loans to the Private Sector



As a consequence, capital spending growth is stagnant after five years, and private consumption (Fig. 11) as well as GDP growth are virtually stagnant due to anemic private consumption and very weak construction. Fig. 12 dramatizes the decline in GDP since the crisis and austerity struck.


Fig. 11 – Greek Private Consumption Growth (in € billions per quarter)



Fig. 12 – GDP in Constant Prices (quarterly in € billions)



But most challenging for Greece, and investors buying Greek debt, is unemployment. The official national rate of 27.6% (Fig. 13) and youth unemployment at a shocking 58.3% rate, down from a high of 60.8% in February 2013 (Fig. 14), mean the economic situation cannot drag on. The number of Greeks employed has fallen dramatically since the crisis began as Fig. 15 illustrates.


Fig. 13 – Greek Unemployment Rate (% of the labor force actively looking for work)



Fig. 14 – Greek Youth (<25 years) Unemployment Rate (% of labor force looking for work)



Fig. 15 – Greek Employed People (millions)



The unemployment numbers and open public anger at austerity are especially worrisome in view of the European Parliamentary and local elections scheduled in late May which are seen as a referendum on the government’s austerity measures. The center-right coalition government, led by the New Democracy Party’s Prime Minister Antonis Samaras, is fragile and risks losing control of key cities, including Athens. It altered voting regulations in late February to disenfranchise non-EU nationals in the municipal elections, and changed procedures for the Euro-Parliament election. The leftwing opposition party, Syriza, criticized these changes as a government appeal to voters tempted to vote for the far-right “Golden Dawn” party which wants to withdraw from the Euro-zone and the EU. A bad setback in the May elections might lead to early legislative elections for all 300 members of the Hellenic Parliament. These must otherwise be held by 2016.

On balance Greece’s return to markets is a happy coincidence of several shifts and changes in the EU economic system, including: improved indicators of budgetary and economic competitive performance; international investors’ urge to buy higher-yielding securities that have an implied guarantee from the Euro-zone’s new institutions designed to protect its financial structure; the ECB’s enhanced role of supervising the banking system; and above all, the central bank’s determination to protect the euro.

But this optimistic reading of Greece’s return to the market does not mean that there will not be another round of stress either for Greece or for the Euro-zone. The Euro-Parliamentary and local elections throughout the EU are likely to reflect public discontent over austerity policies, high unemployment and slow economic growth. If the Greek elections lead to a rejection of the coalition government and its austerity policies, markets could just as easily sell their newly acquired Greek securities and the Troika would find itself back in Athens in emergency mode.




J. Paul Horne is an Independent International Market Economist based in Alexandria, VA and Paris where he was chief international economist for Smith Barney for 24 years. He retired as a Managing Director of Salomon Smith Barney/Citigroup in 2001 but remains active with the National Association for Business Economics, the Global Interdependence Center and the Société d’Economie Politique in Paris.


Source Note: The charts are courtesy of: .


[1] Three Greek banks have borrowed on international fixed income markets recently. National Bank of Greece, rated below investment grade, is preparing to sell Greece’s second senior unsecured bank bond in the past four weeks, Reuters reports. The NBG will be the fourth Greek bank to tap international markets through a share offering, and to raise up to €2.5bn to boost its core capital.

[2] See « The Euro Crisis Update – “Thank you, Greece, for Saving the euro!” (Jan. 2, 2013) – The European Institute