Financial Mail - Investors Monthly
Will Greek standoff prove to be a Trojan horse?horse
Who’ll blink first in this high-stakes game of chicken? asks
There is an uncomfortable feeling of déjà vu about unfolding events in Europe where the threat of a Greek exit from the eurozone has become a key driver of global market sentiment over the past month.
As in 2012 at the height of the eurozone sovereign debt crisis, the behaviour of the rand and local bonds and equities have all become tied to the fate of this bankrupt nation.
Three years ago there was no shortage of doomsayers predicting the worst. From gloomy New York University economist Nouriel Roubini to billionaire investor George Soros, there were many who warned that Europe was sailing into “a perfect storm”.
This time there are fewer calls to batten down the hatches with the consensus view being that a Greek exit (Grexit) is still unlikely, though the probability is growing and is certainly higher than at any time since 2012.
Admittedly, the stakes are not as high this time around as European banks and the financial sector in general are no longer heavily exposed to Greece. The risk of contagion has also declined due to the institution of various bailout funds and backstop mechanisms, as well as the European Central Bank’s €1,1-trillion euro quantitative easing (QE) programme announced last month.
“Still, a Grexit would be pretty bad, setting off a period of intense financial market stress and risk aversion,” says Rand Merchant Bank currency strategist John Cairns. “This would not be 2008 all over again, unless another country followed, but it would hurt the rand, push up bond yields and maybe cause rate hikes.”
The crisis has been caused by the general election victory on January 25 of the populist Greek party Syriza. Its leader, Alexis Tsipras, the country’s new prime minister, initially demanded a 50% cut in Greece’s debt which, at 175% of GDP, has clearly become unpayable.
But instead of bargaining for debt forgiveness with some concessions of his own, Tsipras has threatened to reverse the major structural reforms required of Greece under its EU aid programmes, including rehiring 12 000 civil servants, halting privatisation and raising the minimum wage.
These are all moves that would roll back any competitiveness gains the economy has made over the past few years. They also amount to Greece thumbing its nose at Germany, the mother of European austerity.
It’s no surprise that the policy of extreme fiscal austerity has hindered rather than helped the eurozone’s recovery from the global financial crisis. The consensus has long been that the fiscal austerity imposed should have been much more gradual since growth and confidence can hardly be revived when the withdrawal of government spending serves to drive demand even lower.
“The consequences of Europe’s rush to austerity will be long lasting and possibly severe,” Nobel laureate and Columbia University economics professor Joseph Stiglitz warned in 2012. “Like medieval blood-letters, the country’s leaders refuse to see that the medicine [austerity] does not work, and insist on more of it — until the patient finally dies.”
Today the eurozone faces if not death, then the very real risk of entering a downward spiral of deflation and stagnation, something the massive stimulus of QE is a last-ditch attempt at preventing.
Despite these policy failures, politically it has become impossible for European leaders to accommodate Syriza’s populist backlash given the demands of their own electorates that
The consequences of Europe’s rush to austerity will be long lasting and possibly severe
European taxpayers should not have to foot the bill for years of Greek profligacy, not to mention the boost that caving in would give to populist opposition parties in countries like Spain, Italy and France. So just as quickly as Tsipras has pushed one way, so the ECB has pushed back, announcing recently that it would no longer accept junk-rated Greek sovereign bonds for bank funding.
Though Greek banks will continue to have access to euro system central bank funding via the more expensive vehicle of emergency liquidity assistance (ELA), since the ECB’s Governing Council may restrict ELA operations, the move effectively grants the council the power to turn off liquidity to Greek banks.
Greek markets reacted badly to the news with the Athens Stock Exchange general index initially falling 23% on the news, before finishing down 10% on the day.
“The ECB is playing hardball with the new Syriza administration,” explains Cairns, “In all, the ECB decision has not created any major fallout but raises the stakes in a game of chicken that is now getting a lot of market attention.”
The Economist magazine proposes a sensible solution: “Greece should be put into a forgiveness programme just like any bankrupt African country,” it declares in a recent editorial.
But in exchange for some kind of debt relief, it feels Greece should stick to the key structural reforms required under its bailout agreements in the interests of raising its own competitiveness. Any bargaining over a new rescue programme should be around slowing the rapid pace of fiscal consolidation required.
But Germany and the International Monetary Fund (IMF) are insisting that Greece stick to all fiscal and structural reforms and targets before they will even consider debt relief.
A recent meeting in Berlin between the German and Greek finance ministers served only to underline how far apart the two sides remain. The clock is ticking for Greece: its bailout programme expires at the end of this month with billions of euros in debt coming due soon thereafter.
The consequences for Greece of not striking a deal and exiting the eurozone would be disastrous, say analysts. The country would default on its debts and become locked out of international capital markets. Unable to borrow, it would likely face plummeting growth, rising unemployment and surging inflation.
How this would affect SA would depend on the resilience of the broader eurozone economy and the reaction of global financial markets.
The worst-case scenario is that Greece could exit from the eurozone, triggering contagion that ultimately causes the eurozone to break apart and likely drags the globe into recession. This would likely unleash a huge swell of global risk aversion that would hit all risky assets hard, potentially causing a run on the rand. Such dire predictions were common a few years ago at the height of the eurozone crisis but seem overblown now.
For though Grexit worries have pushed Greek bond yields sharply higher, yields elsewhere in the eurozone have hardly moved. Core country bond yields have actually continued to trend lower.
“There are limited signs of contagion to other countries’ debt markets, at least for now,” notes Rand Merchant Bank chief economist Ettienne le Roux, “This is probably thanks to QE.”
Indeed there are growing signs that the eurozone is slowly healing. The composite PMI index is creeping higher; business confidence levels, though still low, seem to have bottomed out; and consumer spending is gaining momentum. All this is happening despite the turmoil in Greece.
“Fears of the likely damaging impact from a possible Greek default are seemingly being offset by the beneficial impact of the depreciating euro, falling interest rates, and fiscal austerity having largely run its course,” says Le Roux. “Europe also stands to benefit greatly from the falling oil price.”
Given that Europe absorbs close to 30% of SA’s manufactured exports, the hope is that cheaper oil coupled with QE will revitalise the eurozone economy and so lift demand for SA exports.
QE is supposed to raise inflation expectations and stimulate greater borrowing and so ultimately raise growth and inflation in the eurozone. But there is much scepticism as to whether it will get growth going given the ongoing stresses in Europe’s banking system, its high debt levels and the fact that financing is already very cheap.
At the same time, the fall in the oil price is putting downward pressure on consumer inflation (now at -0,6% y/y across the eurozone) and reviving fears that the region could enter a deflationary spiral which could cause years of economic stagnation.
It has become crucial for European economies to undertake deeper structural reforms to labour and product markets to raise their productivity in order to reignite their economies. Allowing Greece to backtrack on this type of reform would clearly set a terrible precedent for the rest of the eurozone.
The odds are that Greece will be forced into a climb-down as it is the side with more to lose. Whether its politicians have the maturity to manage this about-face, and whether Europe’s leaders can be persuaded to make life a little more palatable for the Greek populace in return, remains to be seen.
Allowing Greece to backtrack on this type of reform would clearly set a terrible precedent for the rest of the eurozone