Three members of bailout club seen to have different prospects
ANALYSIS:PERCEPTIONS OF THE euro zone’s bailed out three – Ireland, Greece and Portugal – differ greatly.
The sovereign bond market is one measurable gauge of confidence in states’ solvency and their underlying economic strength.
By this measure Greece is a write-off, Portugal is going in the same direction fast, and Ireland is moving in the other direction almost as fast. But the bond market frequently gets it wrong. Is it right in the case of the euro zone’s bailed out three?
Greece has remained close to the top of the euro zone agenda in 2012 as talks continue with its creditors to agree a massive write-down of its sovereign debt. If the talks fail there are dark mutterings about the consequences of a “disorderly” default. The uncertainty is but one of many negative factors dragging Greece down.
As the first chart shows, the contraction in Greek output is accelerating. The contraction in employment is hardly less precipitous, with the result that the rate of joblessness is now over 18 per cent.
There are many other factors working against stabilisation. The banking system is teetering, sapping confidence and credit from an already chronically weakened economy. Austerity is sucking another source of demand from the economy.
And structural reforms (if any of significance are implemented) are likely to add to the pain before they generate gain – the liberalisation of protected sectors usually causes job losses before the economy-wide efficiencies and price gains feed through.
Another pay-off that should be in evidence already but is not is a rebalancing of the country’s external payments. A big decline in domestic activity tends quickly to narrow a balance of payments deficit – lower domestic demand means less can be bought from the rest of the world and it pushes costs down, allowing exports to become more competitive.
But that has hardly happened in Greece despite everything. As the second chart illustrates, its balance of payments deficit remains massive, at 8.4 per cent of GDP, and has narrowed only slightly since the crisis began.
With so many weaknesses – politically, socially and economically – it is hard to see how and when the situation could hit bottom.
If hope of stabilising the euro zone’s southeastern-most country in the foreseeable future has all but gone, concerns about its southwestern-most economy are growing fast.
This week yields on Portuguese government bonds rose still further and are now at levels first reached in Greece last summer when its debt write-downs were announced.
Portuguese sovereign debt restructuring is no longer a possibility but is expected by bond traders. Despite European leaders’ promises that Greece would be a unique case, the markets don’t believe them. Such is the cost of losing credibility.
The loss of faith is also owed to a lack of belief in Portuguese growth prospects. Over the decade to the outbreak of the financial crisis in 2008, it was among the slowest growing economies in Europe. And despite the absence of anything resembling a bubble in Portugal, both public and private sectors built up ever-higher debts (though neither is as indebted as their Irish counterparts).
Most of this was financed from abroad, as reflected in the still-huge balance of payments deficit illustrated in the second chart. The persistence of that deficit shows that precious little competitiveness gains have been made. This, and the diminutive size of the export sector (among Europe’s small and medium-sized economies, its exports as a percentage of GDP are lower only in Greece), explains in large part the lack of faith in Portugal’s potential to grow its way out of trouble.
The most up to date indicators do little to bolster faith. Industrial production, which never really recovered from the global trade slump in the six months after the collapse of Lehman Brothers, fell below its 2009 nadir in December last. Retail sales in the final third of 2011 fell dramatically and house prices have been in a nose-dive since the first half of last year.
Falling consumer and mortgage credit provision respectively are part of the reason as the banks deleverage, having grown too big and too dependent on non-deposit funding (sounds familiar?).
The Portuguese are swallowing a much bigger dose of austerity in 2012 than we are in Ireland, something that is further weakening demand but earning little credibility in the bond market.
That is in stark contrast to perceptions of Ireland, where strong GDP growth in the first half of last year, a long track record of export-led growth, a return to a balance of payments surplus (see chart two) and consistently positive assessments from the troika have put lots of blue water between this economy and those of Greece and Portugal.
But if international investors could be accused of being somewhat premature in writing off Portugal, they could also be accused of being premature in buying in to the Irish recovery.
For some time there has been divergence between the financial and real economy indicators in the Irish economy. In the second half of 2011, there was precious little to suggest that recovery was doing anything but wilting.
Moreover, the scale of the budget rebalancing effort is if anything considerably greater here than in Portugal or Greece. As the second chart shows, the primary budget deficit, which measures the deficit less interest payments, is far bigger than in the other two countries.
The scale of Irish household deleveraging is also greater than Portugal and Greece, something that will be a drag on growth far into the future.
Bond traders are a fickle lot. They tend to pay only passing attention to smaller economies. It can take little to cause them suddenly to change direction. Ireland is vulnerable to a sudden shift in sentiment.