Greek Update

Currency in Crisis

Greek debt instruments were sold off on Tuesday amid some disappointment that the EU finance ministers failed to provide more detail or color on official support for Greece. The most likely reason for the lack of detail is that that is the extent of the agreement: Wait and see. 

Officials seem committed to verifying that Greece is implementing its fiscal program. The next key date is March 16th when Greece is to submit a progress report. In the mean time, Greece's Finance Minister Papaconstantinou claims that Greece is ahead of schedule in meeting its targets. He cites figures published Feb 12 that showed Greece had a budget surplus of 574 mln euros in January compared with a 1.55 bln euro deficit in Jan 2009. The improvement was largely traced to a one time tax on corporate profits.

European officials seem unimpressed and instead are pressing Greece to prepare "plan b"--new fiscal measures if there is not sufficient progress by mid-March. Among the proposals are a VAT hike, which Spain has implemented, but Greece is more reluctant, a new tax on luxury goods, increased taxes on energy, and cuts in the government's capital investment. 

While March is the focus for progress on the fiscal front, April and May are important from a funding point of view. Reports indicate that in both months, Greece faces about 8 bln euro in maturities that it needs to roll. Estimates suggest that as much as half of the 53 bln euro that need to be raised this year, are expected to be conducted in the April-May period. 

Many officials have argued that any financial aid for EU countries or institutions that is tantamount to direct or indirect bail out violate the EU treaty and could undermine EMU. However, others, including the German parliament, suggest assistance could be made under a clause in the Lisbon Treaty that allows for assistance to for countries facing severe difficulties (such as natural disasters) or an exceptional situation beyond the country's control.

Slowly a more holistic explanation of Europe's financial woes is beginning to emerge. While we have noted that the US trade deficit as a percent of GDP has been roughly halved, as has China's current account surplus, there a substantial imbalances within Europe. Europe's weak domestic demand is tolerated by the ECB. Germany, above others, insists on running substantial trade surplus, exporting as much as 40% of GDP. This combination of stagnant internal demand coupled with the hyper-competitiveness of the German export machine, makes its difficult if not impossible for the weaker members to work their way out the mess.

This is not, of course, to gloss over the poor judgments and choices made by individual members. Instead, the point is that even in the best of circumstances, without substantial structural reforms on the systemic level, developments on the country level will only be able to go so far.