Will Greek stand­off prove to be a Tro­jan horse?horse

Who’ll blink first in this high-stakes game of chicken? asks

Financial Mail - Investors Monthly - - Front Page - Claire Bisseker

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

Pic­ture: REUTERS


Still far apart … Greece’s fi­nance min­is­ter, Ya­nis Varo­ufakis, right, and Ger­man Fi­nance Min­is­ter Wolf­gang Schaeu­ble, be­low.

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