You are currently browsing the category archive for the ‘Greek Crisis Macro’ category.

Yesterday, I received an interesting comment on my Grexit post by Frances Coppola, a comment that is actually not that far from my point of view as would seem on first impression. I ‘d like to use this post to elaborate a bit on this interesting subject.

In my view, Grexit involves (among other things) a trade-off between a balance of payments constraint and large limitations on internal economic policy (and the winners and losers in social groups that policy implementation can create). It is true that the Target2 monetary construction, along with a loose central bank collateral framework can accommodate very large capital flows in the Euro area (BoG Target2 liabilities currently stand at more than €100bn, roughly 55% of GDP). Although most of these capital flows are not directly trade related, the sheer magnitude of Target2 accommodation (and the relative strength of the Euro as a reserve currency) do provide a way around balance of payments constraints for Euro countries, at least for a significant time span. Nevertheless, this relative freedom comes with the cost of well known Euro problems (a fit-for-all monetary policy, low labour mobility, small net fiscal transfers) and the prospect of a loss of a large part of sovereignty if a country is forced to borrow from the ESM and sign an MoU.

A return to a national currency (especially for small deficit countries such as Greece) reintroduces a balance of payments constraint on economic growth. The country has to apply an economic policy consistent with a positive (or at least balanced) long-run balance of payments which allow it to improve/stabilize its NIIP and slowly accumulate FX reserves, which is consistent with relative exchange rate stability. Since most deficit countries are currently experiencing large output gaps, one has to look at cyclically-adjusted current account balances, most probably based on the IMF framework. The EC has performed such an exercise which estimates that Southern European countries still have a structural current account deficit:

EC Cyclically Adjusted Current Account Euro Countries

One can even do a back-of-the-envelope calculation based on the long-run import/domestic demand ratio. For the Greek case, this is around 27-30% which implies, given a 10% output gap, that imports would most probably be 2.5-3% of GDP higher if the Greek economy was running at potential. Since external demand is not closely related to the output gap (at least for a small economy) this implies that the external balance would deteriorate by roughly the same amount if Greece were to slowly try to close its output gap.

An initial devaluation of the newly introduced currency would most likely change the above figure, although I am not a fan of external adjustments through relative price changes (it is my belief that most of the external realignment happens through changes in relative income growth). Nevertheless, a devaluation could result in a (slow) favorable sectoral realignment since (as long as the devaluation did not translate into higher nominal wages) it would increase the profit margins of exporting firms and sectors. That would change the sectoral mix towards export oriented enterprises and help improve the structural external balance up to point.

Still, it is true that Greece (or any similar Euro country) would trade more internal ‘policy flexibility’ for a binding external constraint. This constraint would be made stronger by the fact that debt hierarchy (senior official debt higher than 120% of GDP in the Greek case) would not allow tapping external markets, at least in large quantities.It might be relaxed through a mechanism such as ERM II (which I touched on my previous post on the subject). Ultimately, this becomes a political choice, dependent on the constraints imposed by each choice (Euro membership or a return to national currency). What the July Eurosummit made clear is to what extent austerity is a binding policy constraint inside the Eurozone, at least for highly indebted countries.

Advertisements

A few days ago, this article would have started with the statement that Grexit is closer than ever. Today it seems that Grexit has been postponed for a few months. Yet I fail to understand the underlying strategy of the Greek government since the proposed austerity measures (along with capital controls and low confidence) are destined to push the economy in a deep recession. This recession will make achieving the primary surplus targets even harder and government debt clearly unsustainable (even based on the IMF’s quite optimistic projections). The current program will fail in 2016 and Grexit will come back on the table with a Greek government that enjoys a much more fragile domestic political support and an even weaker economy with a higher output gap.

Probably the biggest problem of returning to the drachma is the fact that there are certain (probable) scenarios where the economy almost collapses and others where we observe the usual path of a large devaluation following an unsustainable currency peg: A short-lived large fall in output followed by a long path of economic growth. Usually people will just choose the scenario that fits their story and ideology and not consider (or even imagine) any other possible paths. The ‘ugly scenario’ basically includes official creditors accelerating Greek debt in the form of EFSF loans and the Greek Loan Facility. That will push Greece in a permanent default state and most probably not make it able to accumulate any foreign reserves (since they would be claimed by creditors). EU structural funds will most likely be lost and Europe will not support the newly created currency exchange rate in any way. Greece will have to function in a ‘semi-pariah’ state with strict and permanent capital controls and an economy that will slowly lose most of its human capital and internationally oriented sectors (such as shipping).

In this blog post I will not analyze the above scenario any further but rather take a closer look at a controlled exit from the Eurozone which will include the help of the other Euro member countries (if not for anything else but to enhance the recovery of their official loans).

First of all let me remind people that currency movements happen mostly because of large gross capital flows and not due to the underlying real trade flows (this paper from BIS Claudio Borio is quite informative). Capital flows, at least in the short-term, will happen for only a few reasons:

  • RoW liquidating domestic claims in order to transform them in foreign currency (think of other Euro banks not rolling over repos with Greek banks or equity investors exiting the Greek stock exchange).
  • Domestic firms and households trying to exchange their liquid assets (mostly deposits) for foreign currency.
  • Institutional players taking large currency positions. This requires being able to borrow large amounts of the currency that will be shorted at favorable terms.

In the Greek case we know that a Grexit will happen under strict capital controls (which are already present), while the terms and price (interest rate) under which the RoW will access the drachma will be determined exclusively by Bank of Greece. Since drachma does not exist in any way, a Eurodollar market is not present and cannot help anyone to circumvent capital controls. Private players outside Greece have already liquidated most of their claims (either equity or interbank loans) while the bulk of Greek liabilities are long-term official loans by other Eurozone member countries. The same is true to a large extent for Greeks themselves who have moved large amounts of liquidity outside Greece. This is the main reason why BoG has more than €120bn in liabilities towards the Eurosystem (Target2 and extra banknotes combined).

As a result, coupled with the presence of capital controls and the fact that Greece already has a strong current account surplus (on a yearly basis) there is actually small scope for strong pressure on the exchange rate of a newly introduced drachma. It is probably one of the few times that capital controls can truly be used as a policy tool and not to trap large funds looking for a way out (as was the case in Iceland). As long as outstanding Greek debt to the ECB (in the form of SMP bonds) and the IMF is rescheduled in the form of a long-term loan by the ESM, the GLF spread over Euribor is lowered to  5bps and interest payments postponed until 2020 (as has already happened with the EFSF loan) Greece will have truly minimal refinancing needs (in terms of foreign currency obligations) for the rest of the decade and be able to slowly accumulate FX reserves through its current account surpluses.

The main subject where a host of different opinions exist is what will happen with ELA financing by BoG and the corresponding liabilities towards the Eurosystem. The story usually goes that BoG will have to default on these liabilities and the Eurosystem having to perform a large capital injection. In my view any such claim is most probably false, at least in the favorable scenario. EU already has an exchange rate mechanism for EU members that do not participate in the Euro area but wish to maintain a controlled exchange rate relationship, called ERM II. This mechanism defines a ‘central exchange rate’ with the Euro, with a fluctuation band of +/- 15%. Intervention at the margins is automatic and unlimited while a short-term financing facility exists with a maturity of 3 months (which can be renewed at least once):

for the currency of each participating non-euro area Member State (hereinafter ‘participating non-euro area currency’) a central rate against the euro is defined;

there is one standard fluctuation band of ± 15 % around the central rates;

intervention at the margins is in principle automatic and unlimited, with very short-term financing available.

For the purpose of intervention in euro and in the participating non-euro area currencies, the ECB and each participating non-euro area NCB shall open for each other very short-term credit facilities. The initial maturity for a very short-term financing operation shall be three months.

The financing operations under these facilities shall take the form of spot sales and purchases of participating currencies giving rise to corresponding claims and liabilities, denominated in the creditor’s currency, between the ECB and the participating non-euro area NCBs. The value date of the financing operations shall be identical to the value date of the intervention in the market. The ECB shall keep a record of all transactions conducted in the context of these facilities.

The very short-term financing facility is in principle automatically available and unlimited in amount for the purpose of financing intervention in participating currencies at the margins.

For the purpose of intramarginal intervention, the very short-term financing facility may, with the agreement of the central bank issuing the intervention currency, be made available subject to the following conditions: (a) the cumulative amount of such financing made available to the debtor central bank shall not exceed the latter’s ceiling as laid down in Annex II; (b) the debtor central bank shall make appropriate use of its foreign reserve holdings prior to drawing on the facility.

Outstanding very short-term financing balances shall be remunerated at the representative domestic three-month money market rate of the creditor’s currency prevailing on the trade date of the initial financing operation or, in the event of a renewal pursuant to Articles 10 and 11 of this Agreement, the three-month money market rate of the creditor’s currency prevailing two business days before the date on which the initial financing operation to be renewed falls due.

My view is that in the case of a Grexit current BoG liabilities towards the Eurosystem will be transformed into a long-term financing facility, capped somewhere close to their current level. BoG will have to pay interest to the Eurosystem, either the 3-month rate applicable to ERM II financing facility or the MRO (as it happens today for Target2 liabilities) with the clear agreement that BoG will use its FX reserves in order to slowly pay back the facility (through annual current account surpluses). This will obviously mean that BoG financing towards Greek banks will remain significant, absent a domestic QE program. Short-term financing by the Eurosystem will be provided in order to facilitate temporary FX needs (the Greek current account is actually in deficit during the first months of a year) and to allow the smooth payment of government liabilities denominated in Euros. Obviously this financing facility will be capped for intramarginal interventions.

As long as the central rate is reasonable and both sides are determined to defend it through monetary policy (interest rates), capital controls and automatic interventions, confidence on the drachma will quickly be strengthened and domestic players will have little reason to try to convert their assets into foreign currency.

Obviously one important problem is the fact that creating the actual physical currency will take time. Electronic payments as well as the over €50bn in Euro banknotes circulating in Greece right now (for a GDP of less than €179bn) will help minimize the short-term impact.

Although I hope the above will remain only a scenario exercise, it is my view that, given the political climate inside Europe and the short-term economic reality, Grexit will emerge again during 2016, especially if the current package is not accompanied by serious debt restructuring.

Yesterday the IMF released its debt sustainability analysis for Greece based on developments during 2015 (but not including the bank holiday and capital controls imposed after the referendum announcement). I consider it a very important document mainly because it shows (probably for the first time) how the basic assumptions of the adjustment programs were terribly optimistic and significantly disconnected from reality. It is also the first time that I know of that the IMF includes a (highly probable) scenario which requires Europe to write off part of Greek official debt (basically the Greek Loan Facility of €53bn) in order for the latter to become sustainable. It seems that the IMF has decided to catch up with reality. Having its largest ever program in arrears probably also played a role.

The first part of the analysis describes how some of the developments since June 2014 improved debt sustainability. These include:

  1. Lower interest rates future path due to easing of monetary conditions in the Euro area which contribute a total reduction of €23.5bn in Greece’s debt up until 2022.
  2. The return of the HFSF bank recapitalization buffer of €10.9bn. Obviously the IMF is not being honest in this point since the buffer will be needed in one form or another for further capital injections in Greek banks and/or for the creation of a bad bank to clear NPLs.
  3. Intra-governmental borrowing of about €11bn to cover debt repayments which the IMF assumes that 2/3 will be sustained for the indefinite future by rolling over this short-term borrowing. This action will lead to an improvement of the debt-to-GDP ratio of 5% GDP.

On the other hand weaker GDP performance and downward revision of historical GDP contributed to an increase by 4% GDP of the 2022 debt-to-GDP ratio. Overall, taking all the above developments into account would improve the 2020 debt ratio to 116.5% (from a projection of 127.7% in the June 2014 review).

Yet at the same time the IMF has to acknowledge reality which includes much lower primary surplus targets, lower privatization proceeds, lower GDP growth, clearing arrears and rebuilding buffers as well as paying down a part of the short-term intergovernmental borrowing. This reality results in a total of financing needs of €52bn from October 2015 up to 2018 with the 12-month forward financing requirements from October 2015 amounting to €29bn.

Let’s take a closer look at a few aspects of ‘reality’.

First of all, primary surplus targets have been reduced from 3% for 2015 and 4.5% for 2016 onwards to 1% during 2015, 2% for 2016, 3% for 2017 and 3.5% for 2018 and beyond. Although in my opinion Greece should only be looking at the structural (cyclically adjusted) primary balance with official lenders taking the risk of short-term economic developments, these short-term targets are obviously much closer to the actual reality on the ground.

What is quite impressive is how the IMF has revised down its privatization proceeds targets. Projected privatizations were €23bn over the 2014-22 horizon yet only €3bn materialized during the last 5 years (the ‘fire sales’ argument of the current Greek government). As a result, the IMF now has much lower (and reasonable) targets of annual proceeds of around €500mn over the next few years. The magnitude of the targets revisions in each review is interesting:

Projected Annual Privatization Proceeds

What is the most important part of the document in my opinion is the analysis of long-term economic growth. The IMF acknowledges that its long-term growth target of 2% was unattainable and conditional on unreasonable assumptions and has now been updated to a still very ambitious target of 1.5%. It is clear from the document that even this target will most likely be missed. Only short-term targets based on closing the output gap and subject to a return of confidence are attainable in my opinion. In the words of the IMF itself:

Medium- to long-term growth projections in the program have been premised on full and decisive implementation of structural reforms that raises potential growth to 2 percent. Such growth rates stand in marked contrast to the historical record: real GDP growth since Greece joined the EU in 1981 has averaged 0.9 percent per year through multiple and full boom-bust cycles and TFP growth has averaged a mere 0.1 percent per year. To achieve TFP growth that is similar to what has been achieved in other euro area countries, implementation of structural reforms is therefore critical.

What would real GDP growth look like if TFP growth were to remain at the historical average rates since Greece joined the EU? Given the shrinking working-age population (as projected by Eurostat) and maintaining investment at its projected ratio of 19 percent of GDP from 2019 onwards (up from 11 percent currently), real GDP growth would be expected to average –0.6 percent per year in steady state. If labor force participation increased to the highest in the euro area, unemployment fell to German levels, and TFP growth reached the average in the euro area since 1980, real GDP growth would average 0.8 percent of GDP. Only if TFP growth were to reach Irish levels, that is, the best performer in the euro area, would real GDP growth average about 2 percent in steady state. With a weakening of the reform effort, it is implausible to argue for maintaining steady state growth of 2 percent. A slightly more modest, yet still ambitious, TFP growth assumption, with strong assumptions of employment growth, would argue for steady state growth of 1½ percent per year.

Greece Real GDP and TFP Growth

What the IMF also acknowledges is that any serious ‘return to markets’ from Greece will quickly make the current debt figures unsustainable because higher market rates will not be consistent with debt sustainability. As a result, in order for official creditors to avoid haircuts, more financing will be needed with concessional financing and a doubling of the grace and maturity period of loans.

It is unlikely that Greece will be able to close its financing gaps from the markets on terms consistent with debt sustainability. The central issue is that public debt cannot migrate back onto the balance sheet of the private sector at rates consistent with debt sustainability, until debt-to-GDP is much lower with correspondingly lower risk premia (see Figure 4i). Therefore, it is imperative for debt sustainability that the euro area member states provide additional resources of at least €36 billion on highly concessional terms (AAA interest rates, long maturities, and grace period) to fully cover the financing needs through end–2018, in the context of a third EU program (see also paragraph 10).
Even with concessional financing through 2018, debt would remain very high for decades and highly vulnerable to shocks. Assuming official (concessional) financing through end– 2018, the debt-to-GDP ratio is projected at about 150 percent in 2020, and close to 140 percent in 2022 (see Figure 4ii). Using the thresholds agreed in November 2012, a haircut that yields a reduction in debt of over 30 percent of GDP would be required to meet the November 2012 debt targets. With debt remaining very high, any further deterioration in growth rates or in the medium-term primary surplus relative to the revised baseline scenario discussed here would result in significant increases in debt and gross financing needs (see robustness tests in the next section below). This points to the high vulnerability of the debt dynamics.

In particular, if primary surpluses or growth were lowered as per the new policy package—primary surpluses of 3.5 percent of GDP, real GDP growth of 1½ percent in steady state, and more realistic privatization proceeds of about €½ billion annually—debt servicing would rise and debt/GDP would plateau at very high levels (see Figure 4i). For still lower primary surpluses or growth, debt servicing and debt/GDP rises unsustainably. The debt dynamics are unsustainable because as mentioned above, over time, costly market financing is replacing highly subsidized official sector financing, and the primary surpluses are insufficient to offset the difference. In other words, it is simply not reasonable to expect the large official sector held debt to migrate back onto the balance sheets of the private sector at rates consistent with debt sustainability.

Given the fragile debt dynamics, further concessions are necessary to restore debt sustainability. As an illustration, one option for recovering sustainability would be to extend the grace period to 20 years and the amortization period to 40 years on existing EU loans and to provide new official sector loans to cover financing needs falling due on similar terms at least through 2018. The scenario below considers this doubling of the grace and maturity periods of EU loans (except those for bank recap funds, which already have very long grace periods). In this scenario (see charts below), while the November 2012 debt/GDP targets would not be achievable, the gross financing needs would average 10 percent of GDP during 2015-2045, the level targeted at the time of the last review.

If grace periods and maturities on existing European loans are doubled and if new financing is provided for the next few years on similar concessional terms, debt can be deemed to be sustainable with high probability. Underpinning this assessment is the following: (i) more plausible assumptions—given persistent underperformance—than in the past reviews for the primary surplus targets, growth rates, privatization proceeds, and interest rates, all of which reduce the downside risk embedded in previous analyses. This still leads to gross financing needs under the baseline not only below 15 percent of GDP but at the same levels as at the last review; and (ii) delivery of debt relief that to date have been promised but are assumed to materialize in this analysis.

What is also important is that a reasonable scenario which includes of long-term growth close to 1% and a medium-term primary surplus target of 2.5% of GDP would require a haircut by official lenders:

However, lowering the primary surplus target even further in this lower growth environment would imply unsustainable debt dynamics. If the medium-term primary surplus target were to be reduced to 2½ percent of GDP, say because this is all that the Greek authorities could credibly commit to, then the debt-to-GDP trajectory would be unsustainable even with the 10-year concessional financing assumed in the previous scenario. Gross financing needs and debt-to-GDP would surge owing to the need to pay for the fiscal relaxation of 1 percent of GDP per year with new borrowing at market terms. Thus, any substantial deviation from the package of reforms under consideration—in the form of lower primary surpluses and weaker reforms—would require substantially more financing and debt relief (Figure 7).

In such a case, a haircut would be needed, along with extended concessional financing with fixed interest rates locked at current levels. A lower medium-term primary surplus of 2½ percent of GDP and lower real GDP growth of 1 percent per year would require not only concessional financing with fixed interest rates through 2020 to cover gaps as well as doubling of grace and maturities on existing debt but also a significant haircut of debt, for instance, full write-off of the stock outstanding in the GLF facility (€53.1 billion) or any other similar operation. The debt-to-GDP ratio would decline immediately, but “flattens” afterwards amid low economic growth and reduced primary surpluses. The stock and flow treatment, nevertheless, are able to bring the GFN-to-GDP trajectory back to safe ranges for the next three decades (Figure 8).

If one includes the fallout of the bank holiday it seems that we have clearly reached the end game. A recession during 2015 along with a low primary surplus will make the current DSA a bit outdated. Deciding to base the DSA on actually achievable targets (which in my opinion only include the ‘adverse scenario’ of 2.5% primary surplus target and 1% long-term GDP growth) will mean that Europe will (finally) have to consider a debt write-off. That is the economic reality on the ground. The way that the official sector reacts to it and the targets it (tries to) sets for the new Greek medium-term program will say a lot about who will bear the costs of further adjustment. In my view the policy of ‘externalizing’ the costs on the Greek economy and ‘extend and pretend’ is almost over, at least in democratic terms. Unfortunately, now will be the time of the politicians, name calling and trying to place the blame on the other party.

PS: It is also quite strange how the IMF puts such high value on ‘structural reforms’, when its own research shows that, at least ‘reforms’ that do not include more funding of investment in high-skilled labor, R&D, ICT capital and infrastructure but target the usual suspects of product and labor market have negative short-term and neutral long-term effects (labor market) or only marginally positive results (product markets). Only financing of serious investment in R&D, ICT capital and (to a lesser part) infrastructure can result in substantial effects on long-term TFP growth.

Short and medium term impact of structural reforms on total factor productivity

Recently I had a conversation about the Greek debt reduction of 2012 and it seems that a lot of people still analyze that period using the nominal haircuts imposed on Greek bondholders with the PSI and the debt buyback of December 2012. The reality though is that the actual reduction in the Excessive Deficit Procedure (EDP) government debt of Greece in that year was far lower.

The PSI exercise reduced Greek debt by a nominal amount of €106bn while the debt buyback resulted in another €20.5bn nominal debt haircut for a combined result of €126.5bn. Yet the PSI also involved reducing debt held by government entities (such as pension funds) which are not counted in the EDP debt (since they are intergovernmental holdings) while it also required a large increase in government liabilities in order to provide the banking system with the necessary funds for recapitalization. As a result, the stock-flow adjustment for 2012 (based on Ameco data) was only -€68bn. If one also takes into account that the 2012 government budget included €5.3bn in support for financial institutions, the end result is a haircut of only €63bn meaning that every Euro in nominal debt haircut actually reduced EDP debt by 50%.

It is true that the recapitalization also created a government asset in the form of bank shares which will result in a future improvement of the headline debt figure. Nevertheless, the Greek financial stability fund (HFSF) has already ‘lost’ close to €10.5bn in covering funding gaps while its bank shares holdings were valued at €17bn at the end of 2014Q3. It still has around €11bn in unused funds although the government’s intention is to use them in creating a ‘bad bank scheme’ to clear banks from NPLs (something with which Ι agree completely). Overall, the room for debt reduction through the HFSF assets seems a bit thin and will probably not produce a drastic improvement of the headline debt figure.

Given that the PSI did not include the SMP and ANFA holdings of the Eurosystem it resulted in a large hit on Greek debtholders with a much lower reduction of the stock-flow adjusted debt (and even of net debt). It is mostly a proof that postponing debt restructuring (and creating a debt seniority hierarchy in the meantime) almost always results in inefficient outcomes.

Since ELSTAT released the GDP figures for 2014Q4 recently I ‘d like to take the opportunity for a few quick comments on the Greek economy.

According to available seasonally adjusted data, Greek GDP decreased 0.4% during 2014Q4 (compared to the previous quarter). a larger movement than the 0.2% figure available in the first flash estimate. Compared to 2013Q4, it increased 1.3% compared to 2013Q4, lower than the initial 1.7% estimate. Overall, during 2014 Greek GDP registered its first increase in volume terms with a growth rate of 0.77%. Nevertheless, nominal GDP decreased significantly from €182.4bn to €179.1bn (a loss of 1.84%), implying a very large GDP deflator change of -2.61%. As a result all debt figures (which are calculated in terms of GDP) continued deteriorating during 2014. Given the ongoing deep deflation (inflation is -2.8%) it is quite possible that even a material increase in the GDP growth rate during 2015 will not be reflected in an actual increase of  nominal GDP.

Looking at the income method in current prices what is evident is the substantial increase in compensation of employees during the second half of 2014 (compared to 2013) with the seasonally adjusted figure (table 5) increasing 3.2% from €29.3bn to €30.2bn. Gross Operating Surplus on the other hand registered a significant fall from €49.84bn to €46.36bn (-7%). A large part of the fall appeared in an increase in taxes on production and imports which increased from €11.96bn to €14.18bn (+18.5%). The increase in compensation is highly important since it signals an improvement in employment (given that wages are falling or stagnant). On the other hand, the large fall in GOS (of the order of €3.5bn in half a year) is not a positive sign, especially since a large part of the fall was reflected in higher tax incomes (which increased €2.2bn during the same period).

Table 7 (which shows the chain-linked volume changes compared to the same quarter of the preceding year) paints a similar picture in terms of the tax burden with taxes on products (production method) increasing close to 7% during 2014H2. Positive signals are:

  • The stable increase in private consumption during most of 2014.
  • The almost double digit increase in exports (with the growth driven mainly by services exports) and
  • The impressive growth (+17.9%) in gross fixed capital formation during 2014Q4, especially compared to the fact that fixed investment was decreasing until 2014Q2. As long as this pattern continues it will signify a shift towards higher investment and eventually allow net investment to also become positive (and increase the Greek economy capital stock). Nevertheless, looking into the detailed breakdown of investment one will notice that the large increase was the result of a substantial (one-off?) growth of transport investment during 2014Q4 which probably reflects new ships. Construction is still in negative territory while equipment investment is only slowly starting to gain momentum.

Overall, the GDP figures provide both positive and negative signs. The large tax burden and the fall in GOS are obviously negative while the increase in labor compensation and fixed investment can become drivers of economic growth in the future (along with exports). The persistent and strong deflationary forces are the most important negative factor since they make debt stabilization a daunting task and create the need for further austerity measures.

Given the latest Greek government debt figures (2014Q3 – €315.5bn), government debt is now 176.2% of GDP. Just for comparison, the latest program review by the IMF (June 2014) was projecting 174.2% (table 1) with a nominal GDP of €181.9bn and a GDP deflator of -0.7%. If the projected figure of nominal gross debt for 2014 is reached (€317bn), then debt will reach 177%. Given the ongoing deflationary dynamics in the Greek economy it is quite probable that the ongoing negotiations about the completion of the program review between the Greek authorities and the ‘institutions’ will quickly reach the conclusion that the debt sustainability analysis is obsolete.

This will be a quick follow-up post on the 2014Q3 employment figures post. The Greek Ministry of Employment publishes monthly figures of employment announcements by employers on an online registration system called ‘Ergani’. Based on the recently announced numbers for December of 2014 (sorry the document is in Greek) I ‘d like to make a few projections on the current state of unemployment in Greece:

Greece Net Employment figures 2014H2 - Ergani

It is quite evident that net employment flows were negative during 2014H2 due to 2014Q4 dynamics (which are not yet reflected on the unemployment survey numbers published by ELSTAT). Compared to 2013 the total difference was 120,000 jobs (from a positive net flow of 43,000 jobs to an outflow of 77,000 employees) with the fourth quarter loosing almost 90,000 jobs, a figure close to three times that of 2013.

Since seasonal adjustment of employment is always a smoothing mechanism which requires a large number of observations my feeling is that October/November monthly employment surveys, as well as the quarterly 2014Q4 survey, will register a significant fall in employment which might result into an increase of the unemployment rate. With a labour force of 4,830 thousand people, the 88,000 jobs shortfall during 2014Q4 is equal to almost 2% which should appear in the unemployment numbers during the upcoming months. Something to definitely keep an eye on.

So it seems that a European QE program is highly probable although Greek government debt is at risk of not being included since it is not rated investment grade and the ECB will only include it in the list of assets purchased if Greece remains in a refinancing program.

In this short post I ‘d like to note a few things on the magnitude of the impact that such a program would have on Greek bonds. Based on the Greek ECB capital key (2%) and the anticipated QE size (which most analysts put around €500bn), the ECB might end up buying around €10bn of Greek debt securities. PSI related bonds principal is now around €29.6bn while long-term bonds issued by the Greek government during 2014 totaled another €6.9bn. Bonds with a residual maturity of up to 10 years are only €12,2bn which, given current market prices, are worth much less than €10bn.

Greek bonds till 2029

As a result, ECB will ultimately be making a bid for all the outstanding market value of long-term Greek bonds (with a residual maturity of up to 10 years), increasing liquidity in the bond market considerably (and making it the largest holder of Greek debt). That will obviously drive current market prices much higher and also allow the Greek government to immediately return to the market since bidders will have a (free) put option of selling most of their holdings to the ECB. As long as the upcoming QE is pari passu with private bondholders (as is the OMT program) and the Greek government establishes a credit line program (which creates another put option for bondholders) the (QE) program will allow an orderly return of the Greek government to private bond markets.

Since the Greek debt maturity profile suggests that only mostly 2015 and 2019 are years that involve large debt refinancing needs (which lowers any default risk post 2015) a QE program will have long-lasting stabilization effects. These effects will be even higher if ECB profits from the program are returned to the corresponding Treasuries (which I suspect will happen if eventually the program involves each NCB buying its own government debt securities).

nov14 Greek debt maturity profile en

Personally I would also like to see a second buyback of Greek debt to take advantage of low market prices and also to lower the nominal value of post-PSI bonds which, due to the EFSF co-financing scheme, are senior to newer bonds issued by the Greek government (a fact that can create difficulties for Greece issuing bonds that have similar maturity dates as outstanding PSI bonds). A possible buyback could be combined with an exchange offer to consolidate the current series (which stretch a 20 year period with low nominal values per bond of less than €1.5bn) into two or three securities that will be of much larger nominal value and liquidity and thus improve market making and secondary market trading.

Greek ELSTAT released the unemployment figures for 2014Q3 today which marked the fall of the unemployment rate to 25.5%, down from 27.2% during the corresponding quarter of 2013. Given the positive outlook of the release I ‘d like to take a closer look at the details of Greek employment and if this drop of the unemployment rate really signifies a substantial improvement of the economy.

Based on various tables of the quarterly employment figures I have constructed the following table of certain numbers that I feel are important:

Greek employment 2013Q3 - 2014Q3

Personally I usually pass through the unemployment rate and go straight to the employment figure. As we can see, although unemployment dropped by 91 thousand people (compared to the same quarter of 2013), employment increased by 53 thousand which resulted in the labor force decreasing by 38,000. What is even more interesting is the fact that a large part of the drop in the labor force was due to a fall of the population over 15yr (-30,000). Obviously the fall in the unemployment rate becomes much less impressive if one looks only at employment while the (steady) fall in the 15+ population and the labor force are certainly not positive signs for the future.

Taking a closer look at the unemployed we see that the fall in that category was only due to people who were unemployed for less than a year while the long-term unemployed actually increased by another 10 thousand to reach close to 930,000 persons. These opposite movements are a worrying sign for the future since they might be indicators for the presence of hysteresis among the long-term unemployment. This will make reducing unemployment much more difficult (given that short-term unemployed are only 6% of the labor force with long-term unemployment reaching 19%).

Moving to employment we observe that the increase came almost entirely from part-time employment. If one also notices that under-employment was the major driver of employment (with under-employed now being close to 6.8% of employment) it is clear that employment growth is driven mainly by short-term, part-time unsecured jobs which probably pay very low salaries. The fall in the unemployment rate actually hides an increase in under-utilization of labor which finds it very hard to enter into full-time steady jobs while long-term unemployed seem to be left out of even these part-time employment opportunities.

Following the tradition of decomposing accounting identities, an exercise that can still provide some very interesting results, this post will decompose the Unit Labor Costs (ULC) paths for Greece and Spain during the past couple of decades. According to Ameco ULC can be decomposed as:

ULC = Compensation per employee / Real GDP per person or ULC = (Compensation of employees / Employees) / (Real GDP / Employment)

Greece

Looking at the first relationship we can observe that since 2009 ULCs were driven mainly by compensation per employee which dropped significantly while real GDP per person exhibited much smaller contributions:

Greece ULC

A much closer look at each factor which drives ULCs can provide important conclusions:

Greece Compensation per employee

Compensation per employee shows a large drop since 2009 which was driven by the fall in total compensation. Although employment was much lower each year, total compensation fell even more lowering the wage costs for each remaining employee.

Greece Real GDP per person

Real GDP per person shows a rather ‘cyclical’ behavior. Between 2008 and 2012 it fell mainly due to the general Greek recession and the drop in real GDP which was not compensated by a corresponding fall in employment (there was some form of labor hoarding). Nevertheless, during 2012 and 2013 the fall in employment was much larger which resulted into a marginal increase in real GDP per person (which can be regarded as ‘productivity per person’) and contributed to the decrease of ULCs.

Overall the ULC decrease since 2009 was accounted mainly by the large fall in employment (which has a positive impact on productivity) and the even larger drop in compensation. These forces probably fed on each other with the fall in employment and compensation eating real GDP and not allowing real GDP per person to contribute significantly to an improvement (fall) in ULCs.

Spain

The Spanish case seems to display rather different dynamics compared to Greece:

Spain ULC

Instead of compensation per employee (which only had marginal contributions), labor productivity was the main driver of ULCs in Spain after 2009.

Spain Compensation per employeeAlthough since 2009 compensation and employment show large changes, these forces managed to counteract each other pointing to the fact that compensation of current employers did not change significantly and only drops in employment lead to corresponding falls in compensation.

Spain Real GDP per personReal GDP per person developments show that productivity was improved mainly through the large fall of employment which was not accompanied by a corresponding drop in real GDP. Although Spain displays unemployment figures similar to Greece the drop in real GDP was only 7% between 2008 and 2013 compared to 24% for Greece.

In general it seems that the ULC improvement in Spain was accomplished on the back of the unemployed while in Greece employed persons also contributed significantly through a large fall of their compensation. This difference can probably also explain (combined with the state of the Greek banking sector) why the fall in Greek GDP was much steeper than Spain’s.

* I am also uploading the relevant excel file which might prove useful for any similar decomposition for other periphery countries such as Italy and Portugal.

I ‘m going to take a quick look on the updated figures for Greek GDP 2013Q3:

Greek GDP 2013Q3 volume change

Obviously the lower volume loss is quite significant although it remains a fact that nominal GDP is still contracting at -5.9% (Q2 and Q3) with the lower volume contraction attributed exclusively to deeper deflation (which is now at -2.9%). Nevertheless, Gross Value Added is now dropping at -3.1%, almost half the rate during 2012. Looking into the expenditure breakdown the most obvious observations are:

  • Household consumption is still contracting significantly at -8.1%. The -6.6% change is attributed only to government consumption rising slightly at +0.1%.
  • Gross fixed capital formation is still at around -10/12% with inventories being the driver of the positive growth in GCF during Q3.
  • Exports of goods and services grew substantially (mainly exports of services) although imports also posted a positive sign, probably driven by the much larger tourist visits.

An alternative way to examine the GDP statistics is to calculate the relative contributions of each expenditure category:

Greek GDP 2013Q3 contributions to volume change

What is quite evident from the table above is that any positive contributions are the result only of inventories and the external sector (usually imports). During 2013Q3 household consumption contribution increased to -60% with the other two positive contributions coming from inventories (29.5%) and services exports (mainly tourism, 16.20%) while imports have now turned negative. Contributions of fixed investment and consumption will need to improve significantly in order for a Greek recovery to be sustainable.

Another interesting exercise is to take a look at the GDP deflators by category (nominal – real growth rates):

Greek GDP Deflators 2013Q3

Its is quite evident that especially during Q2/Q3, deflation accelerated significantly with rates close to -3%. Deflation is present in all expenditure categories while it seems that lower prices in exports are driven up to a point by corresponding import prices reductions. It is rather difficult to expect a turnover in the Greek recession without first observing a reversal of the deflationary forces in the major expenditure categories.

Overall, there are some marginally positive signs yet growth is the result of only a few categories (tourism and inventories) while the deepening deflation cannot easily be regarded as welcome news since it usually coincides with larger output gaps.