While investors are generally aware of the dire state of the western economies’ accounts, quite a few of them are optimistic that these large budget deficits can be closed through a combination of fiscal discipline and expenses reduction. Such optimism, based on other countries’ past experience, is likely to be disappointed for mainly two reasons. Firstly, the closing of the gap relies on consensus growth estimates that appear overly optimistic, leaving room for tax revenues disappointment. Secondly, the budget deficit problem concerns countries accounting for more than 50% of global GDP, meaning that single countries’ past experience does not necessarily provide a reliable guide here.
Andrea Cicione, PNB Paribas
The risks to the EUR from the events in Greece arise from a number of different factors. In summary, however, it boils down to credibility: The credibility of the Greek government in meeting their targets, the credibility of the EU institutions to deal with non-compliant states and the credibility of the EUR itself. In periods of fiscal deterioration, the EUR has typically benefitted from the understanding that all countries would adhere to the conditions of the Growth and Stability Pact (GSP) envisioned by the European Treaty. The GSP requires that they would need to employ deficit reduction programs. The fact that Greece had yet to implement reduction programs, and now evidence that historical financial statistics were not accurate, calls this market assumption into doubt.
Emma Lawson, Morgan Stanley
This is a problem I have touched on before. What exactly is the true size of the Greek 2009 fiscal deficit? Well, according to a report signed by the Greek Finance Minister which has been sent to the EU Commission, and leaked to the Greek finance and business portal Kathimerini (Greek only I'm afraid), it is likely to come in at around 13.7% (and not 14.5%, as I forecast in this post) since the final decision on some hospital expenses which were dancing around in-no-mans land has been to attribute them to the 2008 deficit (and consequently increase the recorded size of that years debt).
Now before going further, we need to have some things very clear in our minds. In the first place, all national accounts are governed by accounting procedures, they are - that is to say - conventions. As I pointed out yesterday, Greece is far from being alone in having "issues" surrounding its debt. Hungary is currently witnessing a major pre-election battle between the two main parties about how much of the debt being accumulated in state owned entities should be passed on to the general government deficit. Spain notoriously has its "Peajes en la Sombra" - or motorways/highways financed with private capital, where there is no evident public debt, but where the Autonomous Community government involved pays revenue to the private companies who built them based on the level of use (rather than openly charging tolls). Here in Barcelona we have just opened a new legal complex (the City of Justice) which seems to have been financed using similar techniques. In fact Spain's central government seems to have far too little quality information about what its regional governments and municipalities are up to, since currently, the government only gets detailed information on revenue, spending and deficits once a year. "We need to get this information more frequently," Economy Minister Elena Salgado told the Wall Street Journal in an interview this week. And then there is Silvio Berlusconi's famous "bridge to nowhere" (Sicily, sorry). Just how is the private capital contribution being structured and serviced?
There are a lot of mirky areas in the financing of all our public sectors, so before entering the "dark areas" of Greek finance, we would do well to remember that. As IMF Hungary representative Iryna Ivaschenko said last week “the definitions [of government debt]are not always comparable, so you should not compare the 3.8% [of GDP deficit forecast] with the 7% (deficit that some economists are arguing exists). You cannot say they are not right, but it is comparing apples and oranges.”
Secondly, I think we would do well to remember that the Greek situation is now out in the daylight, and on the table. Thus it is likely to be remedied. The principal worry being expressed by almost all analysts at the moment is not that the Greek government will not start to put the accounting house in order, but that the Greek population will not swallow the measures being introduced. In this sense I think we need to tread with caution. If the deficit really is 13.7%, then what is important (for Greek credibility) is to get it back under control in a reasonable period of time. What is not interesting is to place hopelessly unrealistic targets on Greece, and then see these objectives not kept.
So, rather than be treated as a whipping boy for all our ills, Greece needs to be cut some kind of slack at the moment. But the other side of that one-and-the-same coin is that the Greek government needs to publicly recognise it needs help to sort this mess out, and ask for it, from the IMF if need be.
All the above having been said, the point about the current chaotic mess in Greek finances is that the deficit irregularities were not acquired using accepted accounting conventions (debt avoidance), but by breaking the generally accepted rules (debt evasion). Rather than resorting to sophistocated techniques of financial engineering, what they are really guilty of is deploying what here in Spain they call "chapuzas" (or back-street botched jobs).
So now for the details of the report.
Will the Real Greek Deficit Kindly Stand Up!
According to the report which Kathimerini had sight of, Greece’s public sector debt could be over the officially reported one by some 300 billion euros. The report, which was requisitioned by the Finance Ministry from an independent committee of six widely respected experts, found that outstanding obligations relating to areas like unpaid arrears to public sector suppliers, interest rate swaps with commercial banks, and debt guarantees for public sector companies have all been excluded from the official data. "Beyond the officially declared 300 billion euros, fiscal chaos is covering up a public debt of many billions of euros" according to Kathimerini. "The Committee recorded in detail all manner of distortions and misunderstandings in the system used to collect and monitor data. But the ingredient that can lead to the conclusion that this is a report to catapult the country's fiscal problems into the limelight are those concerning the manner of recording or not recording of public debt". Some of the comments the experts make on these topics are:
1. Debt as currently recorded has been reduced through a number of "interest rate swaps. One such trade involves the use of Greek banks. The government owes, for example, the National Bank of Greece about 5.5 billion, which is not recorded in outstanding debt. The agreement was originally with Goldman Sachs and it was then passed to National Bank of Greece. The 5.5 billion euros involved is effectively a 30 year loan, and during this time both parties pay interest to each other, with the difference that the State pays a much higher interest to NBG than the NBG pays to the state. That is, the debt is paid off through higher interest payments rather than via the normal amortization process.
2. Credit providers: The European System of National Accounts (ESA) does not take such provision into account because government debts must normally be paid within 60 days. Greece, however, does not comply with the normal condition of early repayment, thereby releasing billions of euros in extra debt, debt which is later recognised and produces a subsequent revision of deficit and debt numbers for the year in question. The most widely quoted case of this is that of public hospitals, which by September 30, 2009 owed suppliers (for the period 2005 - September 2009) 6.3 billion euros. It was the recent addition of these obligations (21 October 2009) which led to the increase in the general government deficit for 2008 and 2009 and the corresponding increase in debt. In addition to the debts of hospital debt, the Committee estimated that there are still further outstanding government obligations of around 6.0 billion euros. Once these liabilities have been paid (or recorded in official figures) the debt will be naturally revised upwards.
3. The debt balance also includes the debt of various public bodies which are guaranteed by the state. Debt guaranteed by the Government at the end of 2009 tamounted o 26.2 billion (or 10.9% of GDP) up from 6.2% of GDP in 2002. About 40% of that debt is owed by the OSE (Greek Railways) and is body is unable to repay (shades of the Hungarian situation here).
4. Much of the above is possible due to the following practice: in order not to increase the budget deficit and debt, public bodies are encouraged to open bank loans guaranteed by the government (but not recorded as outright debt), usually with a higher rate of interest than if the government borrowed the directly and then subsidized the organisations directly. When these obligations are eventually formally assumed by the State, there is then a sudden increase in debt.
As former IMF Executive Board Member for Southern Europe said in a Bloomberg interview yesterday, “In Ireland, it was the banking sector that was the undoing of fiscal management. In Greece it’s the opposite, it’s the country’s fiscal management that is the undoing of the banking system.”