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Jean-Claude Trichet, President of the European Central Bank and Georgios Papaconstantinou, Greek Minister for Economic Affairs and Finance, at a press conference following an emergency meeting of the Eurogroup in Brussels, on Sunday, May 02, 2010, held to ratify the EU-IMF bailout of Greece.
Panic returned to markets on Monday despite the weekend EU-IMF €110bn bailout of Greece. The euro fell below the $1.30 level in New York and fears of Greek contagion and restructuring of debt in four or five of the embattled economies of the 16-member country Eurozone, were exacerbated by news of a fall in German retail sales in March and a slowing of manufacturing in China. However, the economic outlook is not all gloom.
European shares fell almost 3% wiping out 2010 gains on Monday; the benchmark in Athens plunged 6.7% Spain closed down 5.4%. In New York the Dow lost 2%, its biggest drop in three months. Spanish bank, Banco Santander, dipped 7.3% and rival Banco de Valencia slid 7.7%.
German retail sales were impacted by the end of the car scrappage scheme , which was a huge success in 2009. It is not big news that car sales have fallen in early 2010. Chinese manufacturing expansion has eased from a torrid growth rate and the IMF made clear that a team heading for Spain was for the annual review of the Spanish economy. Meanwhile, Fitch Ratings and Moody’s Investors Service dispelled other market rumours of a possible downgrade for Spain saying they both maintain the maximum triple-A rating on Spain with stable outlooks. Spokesmen for both agencies said nothing had been published on Spain’s sovereign rating Tuesday. The Moody’s spokesman added he couldn’t “speculate on future ratings” actions. Last week, Standard & Poor’s Ratings Services (S&P) downgraded Spain by one notch to double-A and Spanish financial markets have been volatile as investor concern spreads from Greece to other countries, like Spain, with large budget deficits and poor economic growth prospects.
S&P has estimated that lenders to Greece banks could lose between 50% and 70% of any bonds' value in a default. European banks hold up to €80bn of Greek bonds, with those in France and Germany having the largest holdings. Two French banks - Crédit Agricole and Société Générale - control Greek banks. Bernstein Research says French and German banks' exposure to Portugal, Italy, Spain and Ireland as well as Greece amounts to at least 20% of their total foreign exposures. "A material devaluation of these assets would be likely to hit the banks' book value hard," they say.
Citigroup analysts estimate the total European bank exposure to the peripheral countries (both sovereign and private credit) at €2.3trn, of which German banks have about €615bn and French banks €700bn. Loans to Italy total €770bn; to Spain, €700bn; Ireland about €460bn (this total is inflated by lending to banks in the IFSC offshore centre); Greece about €200bn.
Fears that Greece is just the tip of the European debt iceberg continues, with CNBC's David Faber:
Last week, Citi chief economist, Prof. Willem Buiter, said in a report (pdf): "We believe it is plausible that a bailout of Greece with tough conditionality would be cheaper for the EA (euro area) member states than a bailout of their own banks, should Greece default unilaterally. The reason is that a tough bailout would discourage recidivism by Greece as well as emulation of its fiscal irresponsibility by other would-be applicants for financial support (e.g. Spain, Portugal, Italy, Ireland etc.). However, a soft bailout of Greece would be more expensive than a bailout of the domestic banks of the other EA members, because it would lead to open-ended and uncapped demand for financial support from all and sundry."
The Wall Street Journal says today: "According to the latest official projections, Greek public debt, currently 108% of gross domestic product, will top 149% of GDP in 2013, the year that the bailout loans, in theory, come due. Assuming an average interest rate of 6% on that debt, Greece would be left paying 9% of its GDP to bondholders, 80% of whom are located abroad. Put another way, 25% of Greek tax revenue would go toward interest payments to foreign bondholders. Meanwhile, Greece's government spending equals more than 50% of GDP and labor productivity is well below the EU average, neither of which bode well for growth going forward.
The EU and IMF insistence that no haircuts and no restructuring are in the cards isn't credible, as yesterday's market turmoil testifies. There is now a real possibility that national parliaments in Germany, Slovakia and other EU states won't approve some of the promised funds. The contentiousness of funding Greece's bailout makes any further bailouts, whether for Portugal or for Greece in a second round, look remote. Far from silencing market speculation about Greece's fate, the bailout has turned up the volume."
Given the fragile recovery in Europe, it is better to try and achieve serious reform in countries like Greece and Ireland now than risk a double-dip recession in Europe. Restructuring if needed could be implemented against a more favourable economic backdrop.
We can see how tough it is in Ireland to change entrenched practices where vested interests have wielded immense power, despite a continuing huge budget deficit.
Greek finance minister, George Papaconstantinou, told the Financial Times on Monday that the previous conservative government, had hired about 100,000 additional civil servants and boosted public spending by more than €20bn during five years in office. He also said up to 200 doctors in the wealthy Athens suburb of Kolonaki who declared annual incomes of less than €25,000 have been subject to investigation for tax evasion and about 20 to 30 will be prosecuted. It's a small start in an endemically corrupt society.
The euro taking a pounding against the dollar today, with David Mann, Standard Chartered Head of Research, Americas and Greg Salvaggio, Tempus Consulting Capital Markets:
A number of other points;
1. The global economy is growing, in particular in Asia and the US; European manufacturing and service sectors are expanding.
2. The European Central Bank has taken aggressive action when required since the onset of the credit crunch in August 2007.
3. Absent the euro, the past two years would have been dominated by news of currency crises in Europe.
4. Convergence is not an easy process as Germans might tell you; after spending huge amounts in the former East Germany, total economic output (which compares per capita GDP) in 2007 in the East was about 70% of that in West Germany.
5. On devaluation as a panacea: Last January, George Provopoulos, governor of the Bank of Greece, wrote in the F T: During the 1980s, Greece had another twin-deficit problem (large and unsustainable fiscal and external imbalances) and its own national currency, the drachma. It waved the magic wand twice, with large devaluations of the drachma in 1983 and in 1985, but in the absence of long-lasting structural adjustment and sustained fiscal contraction. The devaluations were followed by higher wage growth and inflation, with no sustained improvement in competitiveness. Speculative attacks against the drachma were avoided only because of strict controls on capital flows, an option that is no longer feasible or desirable. The twin-deficit problem remained. So much for the magic wand of currency devaluation.”
6. There is no ready solution to strategies that can require a decade or more to have an impact; look at our own foolish expectations from the so-called ’smart economy’; developing new export markets is generally very difficult.
7. It is easier to identify a problem than propose a credible solution. Germany was prudently governed and undergoing reform when it was partytime for Ireland and other misgoverned countries. These countries squandered billions of euros in German financed EU funding.
In 2003, Prof. Hans-Werner Sinn of the Ifo institute, had a book published: Ist Deutschland noch zu retten? (Can Germany Be Saved?) - - Its blurb read:“Taxes keep rising, the pension and health insurance systems are ailing. More and more companies are going bankrupt or are leaving the country. Unemployment has reached alarming levels. Germany is outperformed by its neighbours. It’s growth rates are in the cellar, and it can’t keep up with Austria, the Netherlands, Britain or France. Germany has become the sick man of Europe. “
In Ireland, Mary Harney disdainfully spoke of being closer to Boston than Berlin and today, German success is the cause of the woes in Ireland, Greece and so on!!!
The admirable thing about George Papandreou is that he readily acknowledges where the principal responsibility for Greece’s woes lay.
Bundesbank president, Prof. Axel Weber, has acknowledged that German enterprises will naturally have to focus more on the domestic market than before the crisis and he said in March that Germany’s export success was based on companies embarking on a “painful, but eventually successful, restructuring process, including innovation, outsourcing, wage moderation as well as a balance sheet cleanup.” He said it should "be noted these were market-based adjustments, neither initiated nor managed by policy makers.”
Either way, peripheral countries have to get their economies in better shape; the biggest challenges are from beyond Europe.
8. The credit boom enabled many countries to live beyond their means; that scene has changed and the growth of the leading emerging economies will put further downward pressure on advanced country living standards, as conventionally measured.