Tuesday, October 31, 2017

Greek Debt Basics : Part I - The Economy's Rotten Past

With today’s post I begin a new series focusing on the Greek economy, debt and banking.

Ten years after The Great Global Debt Bubble Implosion, Greece is still regularly in the financial news because of its troubled economy, massive debt and slow pace of necessary structural reforms.  The rest of the PIIIGS (Portugal, Italy, Ireland, Iceland, Greece, Spain) and Cyprus have managed to deal with their problems, resumed growth and mostly dropped off the ""critical" radar screen (Italy is still a bit of a mess).  

Greece, however, continues to labor under its EU/IMF sponsored bailout program initiated in 2010, and progress has come only in fits and starts.There are two main reasons for this underperformance:
  • The economy pre-2010 was based almost entirely on a massive credit bubble which fueled imports, consumer spending and real estate speculation.  The industrial sector, exports and infrastructure investments were essentially ignored or misdirected (the 2004 Athens Olympics spending orgy is a prime example).  Consumer imports, plus astoundingly overpriced homes and commercial real estate drove GDP. higher year after year, particularly when credit became dirt cheap following Greece’s entry into the Eurozone.  Predictably, when the global Debt Bubble burst in 2008 credit vanished and the economy imploded.
  • Greek politics are Byzantine.  Unlike other troubled nations where major parties worked quickly in tandem to deal with the crisis, short-sighted and power-hungry Greek politicians engaged in constant infighting and backstabbing. There were five general elections  between 2010-15, plus one dubious YES/NO referendum on the merits of the bailout program.
GDP plunged 25% within just four years and has been stagnant since 2014 (see Chart 1). There are some expectations of a modest rebound this year and next, mostly due to the strong tourism sector.

Chart 1

As I said above, in the years preceding the Greek implosion the nation’s economy was fueled almost entirely by debt.  There were years when debt rose five, or even six times more than GDP (see Chart 2).  Budget deficits rose sharply, reaching 15% before the EU/IMF stepped in with their bailout.

 Chart 2

As the crisis unfolded after 2010, Greek Government Bond (GGB) yields soared (see Chart 3)  making it impossible for the country to refinance it’s  debt, so a bailout program was thrown together by the so-called Troika of EU, ECB and IMF.  The Troika supplied refinancing in exchange for a) deep haircuts in GGBs b) high primary budget surpluses and c) structural reforms in the public and private sector.  A strict oversight over public finances was imposed requiring continuous progress evaluations. Politicians could not easily stomach the harsh new reality and regularly tried to sugarcoat the bitter pill in their public rhetoric. It did not work.

Chart 3

Confidence evaporated, consumer spending and the real estate/construction industry collapsed, unemployment soared.  The banking sector suffered badly as loan defaults ballooned and deposits melted away.  It wasn’t long before Grexit became a possibility, along with fears for bank deposit seizures (bail-in).

Prospects worsened after a Left-Populist coalition government came to power in 2014 promising to "tear up" the Troika bailout agreement, increase pensions and salaries and oppose planned privatizations and reforms.  Depositors withdrew their money from the banks en masse leading to the imposition of strict capital controls. Greek banks had to request last-resort liquidity assistance from the ECB, known as Emergency Liquidity Assistance (ELA), so as not to shut down.

Things really looked grim in the summer of 2015 as the probability of an immediate and catastrophic Grexit loomed large.

.....To be continued...