Markets eyeing other potential players in the Greek fiscal drama

ANALYSIS:Comparing the economic fundamentals of Greece, Portugal, Spain and Ireland, we come out best, writes PAT McARDLE

GREECE CONTINUES to make the headlines for all the wrong reasons. Unlike Ireland, it failed to grasp the nettle and is suffering the consequences.

At this point, Greece is effectively incapable of borrowing on the open markets with the cost of funding between 10 per cent and 15 per cent.

By comparison, Irish and Portuguese 10-year rates are about 5.4 per cent and 5.8 per cent respectively, while the German benchmark is 3.1 per cent.

The Greek authorities seemed to be unaware of the cost of procrastination, delaying their request for assistance until the last moment. The situation was not helped by the EU announcing a one-year package when a multi-annual programme was clearly required.

Now, at last, discussions on a standard International Monetary Fund (IMF) type of package are under way. But the risk of contagion has increased and yields in the peripheral countries, Ireland included, have risen sharply.

The markets continue to eye potential future candidates – ie sources of profitability – should the efforts to rescue Greece and stop the rot fail.

As IMF managing director Dominique Strauss-Kahn has made clear, what is at stake is not only the economic situation in Greece but confidence in the euro zone as a whole.

The countries most frequently mentioned as candidates for speculation are Portugal and Spain, with Ireland lurking in the background.

The markets have ignored us for some time, given that we have a few tough budgets under our belt and the National Asset Management Agency is proceeding reasonably satisfactorily. At least as important is that we are funding from a strong position, with 60 per cent of this year’s requirement already raised and significant surplus balances in the kitty.

Official statements from EU sources have poured cold water on the notion that Portuguese or Spanish economic fundamentals are comparable to Greece.

However, the markets do not agree. Portugal recently displaced Ireland as the euro state with the second-highest cost of borrowing.

It is interesting, therefore, to look at the economic fundamentals in the three countries and to compare them with Greece in an effort to establish a vulnerability or contagion pecking order.

When times are tough, an ability to grow one’s way out of trouble is vital. Last week, the IMF produced revised data on potential growth rates.

Ireland scores highly, with Greece at the other end of the spectrum. Indeed, the Greek problems are so big that it is hard to see how they can have anything other than pedestrian growth for the foreseeable future.

Next to the bottom comes Portugal with potential growth at least 1 per cent per annum below Ireland.

The balance of payments measures transactions with the rest of the world and is an important indicator that has been ignored all too often since we joined the euro.

Of the four countries, Ireland is again in the best situation, with its current account – the difference between what we import and export – roughly in balance.

Again, Greece and Portugal are at the other end of the scale with large deficits of about 10 per cent of gross domestic product (GDP).

A current account deficit signifies that a country needs external financing via either public or private-sector borrowing.

In our case, the Government continues to raise large amounts of funding abroad but this is offset by private-sector repayments of debt – effective deleveraging.

Greece and Portugal are in a much more difficult position and Spain, too, falls down on this score, with all three needing substantial net foreign inflows for the foreseeable future.

Next we look at the scale of the fiscal situation. Here, it is not the published figures but the underlying structural deficit that matters.

The structural or cyclically adjusted budget deficit is the actual budget balance adjusted for the economic effects of the cycle, ie it is the deficit that will remain when the economy recovers.

The IMF data shows that our structural deficit peaked in 2008 at 12 per cent of GDP. We managed to get it down to 10 per cent last year and the target this year is just over 8 per cent, which puts us back in the pack with the others.

Greece, by contrast, let its structural deficit widen further to 13 per cent in 2009 and the target for this year, which is still being discussed, is 9 per cent, cyclically adjusted. In other words, Greece is being asked to take twice as much pain as we did last year.

Spain and Portugal are in a better starting position but have yet to seriously tackle their budgetary problems.

The main factors affecting a country’s debt dynamics are its initial debt level, the annual increment – ie the size of the budget deficit – and, allied to this, the cost of funding or the rate of interest paid on borrowing.

Greece’s biggest problem is its stock of debt, which is about 120 per cent of GDP. At these levels the danger of an uncontrollable spiral looms large when the annual increment is about 10 per cent. The high starting point plus big annual deficits combine to give Greece a debt service cost that is twice the euro average.

Reflecting their much lower starting points, Spain, Portugal and Ireland all have debt ratios that are still below the euro area average, though this is likely to change in coming years.

While Portugal again appears in second place, behind Greece, the fact that it is close to the average is some comfort. However, that average is now about 85 per cent and is set to go over 100 per cent – a long way away from the old economic and monetary union target of 60 per cent. Europe faces a major question of if, when and how it is going to get its debt ratio back to 60 per cent, a debate that is only just beginning.

All in all, Ireland appears to be in the most comfortable position, with Greece clearly at the other extreme. In addition, Ireland has a credible recovery plan and is at least 18 months ahead of the rest in terms of action taken.

The factors examined confirm the market view that Portugal is next in line after Greece, followed by Spain. The rating agencies, which slashed their ratings on all but Ireland this week, broadly agree.

Moody’s and Standard & Poor’s continue to give Spain a high AA rating, presumably because of its size, but Ireland has a similar rating.

This week, Greece was downgraded to junk status, while Portugal is in an intermediate position.

Ireland can afford no accidents if it is to stay out of trouble. Rejection of the public-sector wage deal would not necessarily matter as long as the markets remained convinced that the Government would secure the necessary spending cuts anyway.

However, it should be clear from recent events that the room for manoeuvre on fiscal policy is as close to zero as it gets.