Looming default the latest chapter in Greek tragedy

SERIOUS MONEY:Zeus, the king of the gods in Greek mythology, was so captivated by the beauty of Europa, the daughter of a Phoenician king, that he transformed himself into a white bull and whisked her away to the Mediterranean island of Crete.

Bulls in the world’s capital markets were similarly enamoured with the economic prospects for the Hellenic republic in the build-up to, and upon, its eventual accession to the euro zone.

The love affair has since soured and the jump in yields available on two-year Greek government debt instruments from less than 7 per cent a year ago to more than 25 per cent today suggests that the question is no longer if but when the nation defaults on its spiralling debt.

Greece enjoyed a golden age following the end of civil war in 1949, with average annual gross domestic product (GDP) growth of close to 7 per cent over the subsequent quarter century. Per capita income that was among the lowest in Europe in the early 1950s exceeded the comparable figures for Ireland and Portugal by the mid-1970s.

Unfortunately, the convergence process came to an end in the 1980s upon its admission to the EEC in 1981, alongside the rise of socialist party Pasok, which engaged in irresponsible wage and spending policies.

Over the next 15 years, economic fundamentals deteriorated to such an extent that GDP growth was among the lowest in Europe at little more than 1 per cent per annum on average, and inflation was among the highest in the region at close to 18 per cent on average from 1980 through the early 1990s.

Furthermore, excessive government spending saw the fiscal deficit reach double digits as a share of GDP by the end of the 1980s. Moreover, the public debt-to-GDP ratio soared from 25 per cent at the time of EU accession to more than 100 per cent by the mid-1990s.

Unsurprisingly, the premium that the Greek government was forced to pay on its debt relative to equivalent German instruments was the highest in the region.

Fiscal consolidation began in earnest in the mid-1990s and the economy appeared to stabilise. Indeed, the inflation rate reached single digits in 1995 and dropped below 3 per cent by the decade’s end, as against a reading of more than 20 per cent 10 years earlier.

The more favourable economic climate alongside its impending entry to the euro zone meant interest rates fell as Greece became a more attractive destination for foreign capital.

Cheap capital contributed to a surge in domestic demand, which meant the current account deficit expanded from less than 4 per cent of GDP in 1997 to 14.5 per cent a decade later. The strong demand pushed up prices and led to a serious loss of competitiveness as the real effective exchange rate appreciated by as much as 30 per cent.

Meanwhile, the government relaxed its fiscal consolidation efforts and took advantage of lower borrowing costs as the premium on Greek public debt versus German bunds dropped from 11 percentage points in the early 1990s to just under 40 basis points before the financial crisis struck.

The excessive spending pushed the budget deficit in excess of 6 per cent of GDP by 2007, while the large public debt at 105 per cent was troubling.

Poor government finances combined with a serious erosion of competitiveness meant Greece was an accident waiting to happen and it came as no surprise when the nation sought financial assistance a year ago.

The €110 billion package cobbled together by the EU and the IMF bought Greece time to undertake necessary fiscal consolidation and implement structural reforms. But it was always wishful thinking to believe this would be the end of the matter given a large structural primary deficit of more than 10 per cent of GDP and spiralling debt load that reached 143 per cent of GDP by the end of last year.

The current EU-IMF programme is scheduled to end next summer, at which point it was hoped the Greeks would be in a position to reaccess the capital markets. Initial progress was encouraging in this regard as expenditures were slashed, but revenues have disappointed and the pace of budget consolidation appears to have slowed.

The shortfall in tax revenues meant the budget deficit came in at 10.5 per cent of GDP last year, which missed the original target of 8.4 per cent.

Projections for this year remain too optimistic given that the economy is still mired in recession and must endure deflation to restore competitiveness – though the current inflation rate is still uncomfortably high, being close to 4 per cent.

Market pricing suggests Greece will not be able to raise funds on the capital markets next year and consequently, the government faces a funding gap of some €27 billion. With no stabilisation in the public debt-to-GDP ratio forthcoming, the probability of default continues to increase.

Greece has defaulted on its obligations five times since it gained independence from the Ottomans in 1829 and the latest chapter in the nation’s history suggests it will default again.

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