Econ­omy needs re­forms, in­vest­ment

Greece’s re­cov­ery will re­quire more than bank re­cap­i­tal­iza­tion and sup­ply of more credit to the mar­ket

Kathimerini English - - Front Page -

ANAL­Y­SIS The ECB is ex­pected to de­cide mid­week on the re­cap­i­tal­iza­tion of Greek banks, set­ting in mo­tion the process which pol­i­cy­mak­ers hope will be com­pleted be­fore the end of the year. Even if ev­ery­thing goes well, one shouldn’t be un­der any il­lu­sions. Re­solv­ing credit sup­ply con­straints is not enough to avoid Ja­paniza­tion.

It is gen­er­ally ac­cepted that the economies of coun­tries with large for­eign di­rect in­vest­ment (FDI), such as Ire­land, and/or pri­vate sec­tor com­pa­nies with strong liq­uid­ity po­si­tions can grow at a sat­is­fac­tory rate with lit­tle or no credit growth. In con­trast, coun­tries which can­not count much on FDI flows and/or have com­pa­nies with rel­a­tively weak liq­uid­ity po­si­tions need pos­i­tive credit growth to ad­vance.

Greece be­longs to the sec­ond cat­e­gory and needs credit growth to sus­tain strong real gross do­mes­tic prod­uct rates in the medium term and re­pay its public debt. In this re­spect, credit avail­abil­ity mat­ters and the prospec­tive bank re­cap is im­por­tant. How­ever, the author­i­ties will have to avoid past mis­takes and en­sure Greek banks will be over­cap­i­tal­ized this time to be able to deal ef­fec­tively with the large stock of bad loans and ab­sorb other shocks in the fu­ture as we have ar­gued re­peat­edly.

Although Ja­pan is another an­i­mal, as we say, one can draw some use­ful lessons from its bank­ing sec­tor. To start with, let’s re­mem­ber that the trig­ger for the prob­lems en­coun­tered by the Ja­panese bank­ing sec­tor in the last few decades was the large land and stock price declines that be­gan in the early 1990s.

Within three years of their peak in 1989, Ja­panese stocks had lost about 60 per­cent of their value. In ad­di­tion, af­ter the 1992 peak of com­mer­cial land prices, they fell by roughly 50 per­cent over the next 10 years. The large drops in these prices im­paired col­lat­eral val­ues to such an ex­tent that any bank­ing sys­tem would have found it hard to ad­just. This is be­cause the sit­u­a­tion war­ranted very high pro­vi­sions for non­per­form­ing loans and sig­nif­i­cant write-offs.

How­ever, the po­lit­i­cal and reg­u­la­tory re­sponse of the Ja­panese author­i­ties was to es­sen­tially deny the ex­is­tence of the prob­lem and de­lay the restruc­tur­ing of the banks and any se­ri­ous re­forms. Banks had to com­ply with min­i­mum cap­i­tal ad­e­quacy ra­tios while some of them were na­tion­al­ized.

In this en­vi­ron­ment, Ja­panese banks con­tin­ued to ex­tend credit to in­sol­vent cor­po­ra­tions, bet­ting they would re­cover or the gov­ern­ment would bail them out. Banks also felt they would have to roll over even prob­lem­atic loans be­cause they would have faced crit­i­cism from the public that they con­trib­uted to the deep­en­ing of the re­ces­sion by deny­ing credit to needy com­pa­nies.

In ad­di­tion, Ja­panese banks came un­der pres­sure from the gov­ern­ment to pro­vide more loans to small and medium-sized com­pa­nies to ease the credit crunch. The end re- sult was to cre­ate zom­bie banks and many non­pro­duc­tive com­pa­nies on life sup­port from the bank­ing sys­tem, con­tribut­ing to the eco­nomic stag­na­tion.

One can dis­cern some sim­i­lar­i­ties be­tween the Greek and Ja­panese bank­ing sec­tor ex­pe­ri­ence dur­ing the years of eco­nomic cri­sis, although the roots of their prob­lems are dif­fer­ent. At this point, Greece has the op­por­tu­nity to cope with the credit sup­ply con­straint via the re­cap­i­tal­iza­tion of its banks. Hav­ing said that, one should also bear in mind that clean­ing up loan port­fo­lios re­quires time and usu­ally has a neg­a­tive im­pact on the banks’ will­ing­ness to lend.

Clean­ing up bank bal­ance sheets and boost­ing their cap­i­tal ad­e­quacy ra­tios is def­i­nitely nec­es­sary for credit in­sti­tu­tions to play their in­ter­me­di­ary role, but liq­uid­ity is also im­por­tant for ex­tend­ing more loans and the Greek banks are short of cash. At­tract­ing de­posits with­drawn over the last few years could be a so­lu­tion but it will be much more dif­fi­cult af­ter the cap­i­tal con­trols and the poli­cies pur­sued by the tax author­i­ties, as the feel­ing of dis­trust among de­pos­i­tors ap­pears to be wide­spread.

Even if one as­sumes the re­moval of the credit sup­ply con­straint for credit growth, there is no rea­son to be­lieve the credit de­mand con­straint will not be bind­ing and the lat­ter may be more im­por­tant. Af­ter all, the eco­nomic out­look is not promis­ing, busi­ness sen­ti­ment is down­beat again, a num­ber of com­pa­nies are try­ing to delever­age as they still face high debt lev­els and doubts about the im­ple­men­ta­tion of the third eco­nomic pol­icy pro­gram per­sist. Some in­di­vid­u­als and busi­nesses even ques­tion whether the newly elected gov­ern­ment will be able to sur­vive the im­ple­men­ta­tion of the new pro­gram.

The above pic­ture does not bode well for credit growth and this should be a cause for con­cern be­cause Greece lacks sig­nif­i­cant FDI flows and does not have a pri­vate sec­tor with a strong liq­uid­ity po­si­tion. This is more so since the lo­cal econ­omy seems to be slid­ing back into re­ces­sion af­ter an in­ter­lude of eco­nomic growth. Even if we as­sume the good sce­nario of re­cov­ery in the sec­ond half of 2016, it may take a few more quar­ters be­fore credit growth turns pos­i­tive.

All in all, it will take more than bank re­cap­i­tal­iza­tion and the re­moval of the credit avail­abil­ity con­straint to re­store credit growth. Boost­ing ag­gre­gate de­mand via more EU-funded and other in­vest­ments and im­ple­ment­ing more struc­tural re­forms may do the job by speed­ing up the re­turn to credit growth and eco­nomic ex­pan­sion.

Author­i­ties will have to avoid past mis­takes and en­sure Greek banks will be over­cap­i­tal­ized this time to be able to deal ef­fec­tively with the large stock of bad loans and ab­sorb other shocks in the fu­ture.

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