Monday, March 29, 2010

Will Greece Government Be Able To Raise Sufficient Money To Finance Itself Out?

The recent Greece’s economic woes have certainly made its way into the heart of media. Economists, policymakers and politicians from all over the world are aroused once more. All are eager to see how the whole Eurozone economies come as one during stormy days and whether the single currency plan is viable or not in long term

How Greece end up with such mess?

Put in simple. Greece has been living beyond its mean in the past decade. To sustain such lifestyle, the government engaged in heavy borrowing and went on something of spending spree. As a result, public spending soared and public sector wages practically doubled that time. Unfortunately, this was not matched by the increase in tax revenue due to the widespread of tax evasion. However, stern action was not taken as the Greece government thought that the economic boom is likely to last ‘forever’ and they will always have their ways to finance themselves out

Hence when the global financial crisis hit out of nowhere, Greece was too ill-prepared to cope. The reported budget deficit was 12.9% last year, somewhat 4 times above the permissible level under the Growth and Stability Pact. Meanwhile the forecasted national debt is expected to exceed 130% in year 2011, again overshooting the stipulated level of 60%

Will Greece be able to get the funding needed?


(1) Initiative to fix its balance sheet. Whatever is the argument, it seems that this round the Greece government is really committed to bring the deficit under control. It has enacted an unpopular but necessary measure of fiscal austerity. There will be freeze on public sector wages. Retirement age on the other hand is increased to reduce the burden of pension payments and lastly the fuel taxes raised. If all these are successful to hammer the deficit, ideally market participants would be less ‘disturbed’ and once more willing to buy the bonds issued

(2) Higher interest rates. Usually, private sectors will be very glad to snap up government-issued bonds. This is because it is perceived as safe, upon the assumption that governments usually don’t default. Furthermore, investors are guaranteed a steady stream of income periodically, depending on the promised interest rate. However, this is not the case for Greece. Its government had overspent in the past and signs of defaulting are imminent. Even rating agency like Fitch downgraded its credit rating to BBB+, the lowest among 16 euro nations. Given that the risk of lending has increased, the only way to get the finances needed is to increase interest rates offered. That is a must to compensate the risk that bond buyers are assuming

(3) Joint-bail out programme. The plan was worked out in Brussels, and yes Greece is guaranteed a safety net of up to 22 billion euros if it fails to obtain the credit needed. But of course, the move has irritated some of its European partners like Germany. Chancellor Angela Merkel has strongly urged that Athens itself can solve the problem and any form of bail-out shouldn’t be allowed under the single currency rules

I personally feel that she should be more rationale and flexible. Such rigidity will only force Greece to fall out from the common currency area where once again it could allow its currency to fall in value and therefore gain some competitive ground. If that were to happen, we know that Portugal, Ireland and Spain (PIGS) will soon be tempted to do the same. The financial exodus would cause huge ruptures in the financial markets as investors are fearful that other nations might follow suit, thereby leading to the breaking up of monetary union

May not be able to get sufficient funding:

Fall in income. This is the most fundamental economics argument. Slash in public spending followed by rise in taxes will only worsen the current economic pain. This is because fall in economic growth will lead to falling average income. Households will have lesser to spend and firms facing deteriorating profits will be more reluctant to invest, thus igniting the vicious cycle over and over again through the negative multiplier effect. Putting elderly people to two more years of work will never help either, due to poorer health condition and also declining productivity. Not to forget, lower take-home pay will further erode the level of savings in Greece’s banks, which are also the biggest fans of government bonds

(2) Shaky investors’ confidence. When it comes to financial market, all I can say is sentiment. Consider Japan with its national debt of 190% of GDP and Singapore 118% of GDP. Despite close to or much higher than the level of Greece for some time, there is not much fuss about it, all because these two countries have high income per capita and of course better reputation in debt repayment. On the other hand, Greece just like Argentina has varying degrees of debt default. Therefore they are having such tough time convincing the investors that it will not happen again

Well, maybe investors are right this time. Debts too high for such size of economy, unemployment of 10%, fiscal and monetary constraint all sum to one word-default. The evidence is there and it is just some of us choose to ignore. Greece’s two-year government bonds are persistently on a heavy sold off. As the supply of bond in market increases, its price will fall. But investors are promised a fixed amount of return, which means that the effective interest rate attached onto it must increase. Because of this, Greece government has to pay 6%, double what Germany has to pay. This indicates how risky investors think it is to hold Greece debt. Most of the money fled to other safe haven


倫音 said...
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Lawrence Low said...

To Marry, thanks for the feedback. Will do so