Greece in 60 Seconds!

What’s the problem?

Modern Greece has never been the most spendthrift country. It has a large public service, generous pensions (17% of GDP, the highest in Europe), early retirement ages (75% of Greeks retire before 61) and substantial social grants. It is also second only to the United States within NATO in terms of the proportion of income that it spends on defence. Unfortunately, Greece also has high levels of tax evasion, powerful unions, special interest groups that protect incumbents and other structural issues. The net result is that Greece is uncompetitive and the government runs a budget deficit, which it has to fund through borrowing.

Greece joined the European Union in 1981 and adopted the euro in 2001. Being part of same currency union as Germany and France gave investors confidence in Greece and allowed its government to borrow money at much lower rates than it normally would. An unwelcome side effect of the euro was that it made Greece’s labour costs higher and its exports less competitive. As a result, Greece consumed more than it funded through exports and had to borrow further to finance this trade deficit. Greece’s issues meant that it was particularly badly hit by the global financial crisis that started in 2008.

Under the Maastricht Treaty, members of the EU agree to keep their budget deficits to below 3% of GDP and public debt to 60% of GDP. In 2009, a new Greek government was elected under George Papandreou and confessed that Greece had been fudging its numbers. The budget deficit was actually 15.7% and debt 130% of GDP. Interest rates on Greek debt skyrocketed and it was no longer possible to borrow money in the public markets. The European Commission, the European Central Bank and the IMF (the “Troika”) bailed out the Greek government by loaning it money under a series of programs. These bailouts were conditional on the implementation of austerity measures, structural reforms and privatisation of government assets.

The conditions of the bailout programs were deeply unpopular with Greek voters and in December 2014 they elected Syriza, a far left party, that promised to end austerity and renegotiate the bailout package. Negotiations were characterised by animosity and mistrust and Syriza’s demands ultimately proved incompatible with Germany’s hard-line attitude. On June 26th the Greek government unilaterally broke off negotiations and Prime Minister Alexis Tsipras announced a referendum on the bailout package. This was very unpopular with Greece’s creditors who then released a more generous proposal that they were prepared to offer Greece if it had remained in the negotiations. Bizarrely then, on Sunday July 5th Greece voters overwhelmingly rejected a bailout offer that was no longer on the table and that had been superseded by a more generous offer (you may need to re-read this paragraph, but yes...that's what happened).

In the meantime, Greece became the first developed country to default on the IMF when it missed a EUR 1.5bn payment on 30th June. In order to prevent a collapse in the Greek financial system, banks were closed, ATM withdrawals were limited to EUR 60 per day and capital controls were implemented to stop money fleeing the country.

Does this mean that there will be a Greek exit from the Euro (Grexit)?

Shortly after the referendum, European leaders put the onus on Greece to propose a new deal with its creditors and gave the country a deadline of midnight on Thursday 9th July. Greece made the deadline by only a few hours and Europe’s bailout monitoring institutions now have just 48 hours to evaluate the plan before it is handed over to European finance ministers on Saturday. If Greece is unable to conclude a deal it will be unable to borrow money in euros. To continue operating, it will have to issues IOU’s, in effect setting up a parallel currency and taking the first steps to a new drachma. 

Should I be worried?

Greece is less than 2% of EU GDP, so the biggest risk has always been that the crisis would spill over into other vulnerable southern European countries. This would set off a downward spiral leading investors to pull money out of perceived risky markets – Africa included. Interestingly, that hasn’t happened. The borrowing costs of Portuguese, Italian and Spanish debt have gone up slightly, but nearly not as much as they could have. The Spanish Prime Minister also recently used the troubles in Greece as a warning of what happens when voters elect irresponsible left wing governments. Most importantly though, the Greek government’s new proposal is bizarrely similar to the compromise offer made by creditors two weeks ago – the one that was rejected in the referendum. Stock markets like the proposal and the Eurostoxx 50 is up nearly 3% as we type 

DR ANDREW LOUW CFA