Just What Is The Real Level Of Government Debt In Europe?

“If you don’t fully understand an instrument, don’t buy it.”

To the above advice from Emilio Botín, Executive Chairman of Spain’s Grupo Santander, I would simply add one small rider: Don’t sell it either, especially if you are a national government trying to structure your country’s debt.

In a fascinating article in today's New York Times, journalists Louise Story, Landon Thomas and Nelson Schwartz begin to recount the mirky story of just how the major US investment banks have been able to earn considerable sums of money effectively helping European governments to disguise their growing mountain of public debt.

Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts.

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting. The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

In fact, concerns about what it is exactly Goldman Sachs have been up to in Greece are not new, and the Financial Times have been pusuing this story for some time, in particular in connection with the investment bank's ill fated attempt to persuade the Chinese to buy Greek government debt (and here, and here). Nor is the fact that the Greek government resorted to sophistocated financial instruments to cover its tracks exactly breaking news, since I (among others) have been writing about this topic since the middle of January - Does Anyone Really Know The Size Of The Greek 2009 Deficit? - following the arrival in my inbox of a leaked copy of the report the Greek Finance Minister sent to the EU Commission detailing the issues.

What is new in today's report from the NYT team is the extent to which they identify the problem as a much more general one, involving more banks and more countries, since "Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere". I very strongly suggest that our NYT stalwarts take a long hard look at what has been going on in Spain, and especially at the Autonomous Community level.

So the question naturally arises, just how much in debt are our governments, really? As the NYT team point out, Eurostat has long been grappling with this matter, and as far back as 2002 they found themselves forced to change their accounting rules, in order to try to enforce the disclosure of many off-balance sheet entities that had previously escaped detection by the EU, since up to that point the transactions involved had been classified as asset "sales", often of public buildings and the like. Following advice paid for from the best of investment banks many European governments simply responded to the rule change by reformulating their suspect deals as loans rather than outright sales. As we say in Spain "hecha la ley, hecha la trampa" (or in English, when you close one loophole you open another). According to the NYT authors:

"As recently as 2008, Eurostat.... reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.”"

So just what is all the fuss about. Well, in plain and simple terms it is about an accounting item known as "receivables". Now, according to the Wikipedia entry:

"Accounts receivable (A/R) is one of a series of accounting transactions dealing with the billing of a customers for goods and services received by the customers. In most business entities this is typically done by generating an invoice and mailing or electronically delivering it to the customer, who in turn must pay it within an established timeframe called credit or payment terms."

However, as we can learn from another Wikpedia entry, often the use of "accounts receivable" constitutes a form of factoring, and this is where the problems Eurostat are concerned about actually start:

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.

But how does all this work in practice? Well, the World Wide Web is a wonderful thing, since you have so much information near to hand, at just the twitch of a fingertip. Here is a useful description of what are known as PPI/PFI schemes, from UK building contractor John Laing:

A Public Private Partnership (PPP) is an umbrella term for Government schemes involving the private business sector in public sector projects.

The Private Finance Initiative (PFI) is a form of PPP developed by the Government in which the public and private sectors join to design, build or refurbish, finance and operate (DBFO) new or improved facilities and services to the general public. Under the most common form of PFI, a private sector provider like John Laing will, through a Special Purpose Company (SPC), hold a DBFO contract for facilities such as hospitals, schools, and roads according to specifications provided by public sector departments. Over a typical period of 25-30 years, the private sector provider is paid an agreed monthly (or unitary) fee by the relevant public body (such as a Local Council or a Health Trust) for the use of the asset(s), which at that time is owned by the PFI provider. This and other income enables the repayment of the senior debt over the concession length. (Senior debt is the major source of funding, typically 90% of the required capital, provided by banks or bond finance). Asset ownership usually returns to the public body at the end of the concession. In this manner, improvements to public services can be made without upfront public sector funds; and while under contract, the risks associated with such huge capital commitments are shared between parties, allocated appropriately to those best able to manage each one.

And for those still in the dark, Wikipedia just one more time comes to the rescue:

The private finance initiative (PFI) is a method to provide financial support for "public-private partnerships" (PPPs) between the public and private sectors. Developed initially by the Australian and United Kingdom governments, PFI has now also been adopted (under various guises) in Canada, the Czech Republic, Finland, France, India, Ireland, Israel, Japan, Malaysia, the Netherlands, Norway, Portugal, Singapore, and the United States (amongst others) as part of a wider program for privatization and deregulation driven by corporations, national governments, and international bodies such as the World Trade Organization, International Monetary Fund, and World Bank.

PFI contracts are currently off-balance-sheet, meaning that they do not show up as part of the national debt as measured by government statistics such as the Public Sector Borrowing Requirement (PSBR). The technical reason for this is that the government authority taking out the PFI contract pays a single charge (the 'Unitary Charge') for both the initial capital spend and the on-going maintenance and operation costs. This means that the entire contract is classed as revenue spending rather than capital spending. As a result neither the capital spend nor the long-term revenue obligation appears on the government's balance sheet. Were the total PFI liability to be shown on the UK balance sheet it would greatly increase the UK national debt.

And here are two more examples of what is involved which were brought to light by a quick Google. First of all, the case of Italian health payments. Now according to analysts Patrizio Messina and Alessia Denaro, in this report I found online from Financial Consultants Orrick:

In the last years many structured finance transactions (either securitisation transactions or asset finance transactions) have been structured in relation to the so called healthcare receivables.The reasons are several. On one side, the providers of healthcare goods and services usually are not paid in time by the relevant healthcare authorities and therefore, in order to gain liquidity, usually assign their receivables toward the healthcare authorities. On the other side, due to the recent legislation that provides for very high interest rates on late payments, the debtors as well as banks and other investors have had the same and opposite interest on carrying out different kind of transactions. In this brief article we will analyse, after a quick description of the Italian healthcare system, some of the different structures that have been used in relation to transactions concerning healthcare receivables and, in particular, we will focus on transactions concerning the so called “raw receivables”, which are lately increasing in the Italian market practice, by analysing the legal means through which it is possible to ascertain/recover such receivables.

This system thus has two advantages (apart from the fact that it effectively hides debt). In the first place the healthcare providers gain liquidity in order to continue to run hospitals, pay doctors, etc, while those who effectively intermediate the transaction earn very high interest rates for their efforts, interest payments which have to be deducted from next years health care provision, and so on.

As the Orrick report points out, Italy’s national healthcare service (servizio sanitarionazionale, “nhs”) is regulated by the legislative decree of December 30, 1992, no. 502 (“decree 502/92”).The reform introduced by decree 502/92, as amended from time to time, provides for a three-tier system for the healthcare service, as outlined below: State level The central government provides a national legislation limited to very general features of the NHS and decides the funds to be allocated to the single regions according to specific criteria (density of population, etc.) for the NHS.

As the Orrick analysts note: "the Healthcare Authorities usually pay the relevant Providers with a certain delay".

Usually, when healthcare funds are allocated, in the national provisional budget, the central government underestimates the amount of healthcare expenditure. Since the central government does not provide regions with enough funds, regions are not able to provide enough funds to Healthcare Authorities, and payments to the Providers are delayed. Since the Providers need liquidity, they usually assign their receivables toward the Healthcare Authorities. To deal with all the above issues, Italian market practice has been developing an alternative system of financing through securitisation and asset finance transactions of Healthcare Receivables.

As the analysts finally conclude:

Despite of the risks concerning the judicial proceedings, Italian market players are still very interested on carrying on securitisation transaction on this kind of asset, principally because Legislative Decree no. 231/02 provides for very high interest rates on late payments (equal to the interest rate applied by ECB plus 7%) - my emphasis

Another technique Eurostat have identified as a means of concealing debt relates to the recording of military equipment expenditure, as described in this report I found dating from 2006. At the time Eurostat were worried about the growing provision of military equipment under leasing agreements. Basically they decided that such provision was debt accumulable.

Eurostat has decided that leases of military equipment organised by the private sector should be considered as financial leases, and not as operating leases. This supposes recording an acquisition of equipment by the government and the incurrence of a government liability to the lessor. Thus there is an impact on government deficit and debt at the time that the equipment is put at the disposal of the military authorities, and not at the time of payments on the lease. Those payments are then assimilated as debt servicing, with a part recorded as interest and the remainder as a financial transaction.

However, a loophole was found in the case of long term equipment purchases:

Military equipment contracts often involve the gradual delivery over many years of a number of the same or similar pieces of equipment, such as aircraft or armoured vehicles, or including significant service components, such as training. Moreover, in the case of complex systems, it is frequently the case that some completion tasks need to be performed for the equipment to be operational at full potential capacity. Some military programmes are based on the combination of several kinds of equipment that may be completed in different periods, so that the expenditure may be spread over several fiscal years before the system, globally considered, becomes fully operational.

In cases of long-term contracts where deliveries of identical items are staged over a long period of time, or where payments cover the provision of both goods and services, government expenditure should be recorded at the time of the actual delivery of each independent part of the equipment, or of the provision of service.

Payment for such items are only to be classifed as debt at the time of registering the actual delivery, which may explain why, if my information is correct, the Greek military as of last December were still officially "testing" two submarines which had been provided by German contractors, since final delivery had still to be formally registered, and the debt accounted.

A lot of information about the kind of things which were going on before the 2006 rule change can be found in this online presentation from Europlace Financial Forum. Here are some examples of private/public sector cooperation in Italy.



And here's a chart showing a list of advantages and possible applications:



Now, at the end of the day, you may ask "what is wrong with all of this"? Well quite simply, like Residential Mortgage Backed Securities these are instruments that work while they work, and cause a lot of additional headaches when they don't. I can think of three reasons why debt aquired in this way in the past may now be problematic.

a) they assume a certain level of headline GDP growth to furnish revenue growth to the public agencies committed to making the payments. Following the crisis these previous levels of assumed growth are now unlikely to be realised.
b) they assume growing workforces and working age populations, but both these, as we know, are now likely to start declining in many European countries.
c) they assume unchanging dependency ratios between active and dependent populations, but these assumptions, as we also already know, are no longer valid, as our population pyramids steadily invert.

Given all this, a very real danger exists that what were previously considered as obscure securitisation instruments, so obscure that few politicians really understood their implications, and few citizens actually knew of their existence, can suddenly find themselves converted into little better than a glorified Ponzi scheme.

And if you want one very concrete example of how unsustainable debt accumulation can lead to problems, you could try reading this report in the Spanish newspaper La Verdad (Spanish, but Google translate if you are interested), where they recount the problems being faced by many Spanish local authorities who are now running out of money, in this case it the village of San Javier they have until the 24 February to pay a debt of 350,000 euros, or the electricity will simply be cut off! The article also details how many other municipalities are having increasing difficulty in paying their employees. And this is just in one region (Murcia), but the problem is much more general, as Spain's heavily overindebted local authorities and autonomous communities steadily grind to a halt.

Few Surprises As Greece's Economic Contraction Accelerates

Well, I may say there were no surprises, but in fact the Greek economy contracted more than many observers expected in the fourth quarter, while downward revisions to the rest of 2009 converted the present recession into the country's worst since 1987. Evidently the latest numbers offer the first warning that all may not be as simple as it looks on paper for the Greek government's plan to set their finances straight. As far as I am concerned the latest numbers simply confirm what should already have been abundantly evident - correcting the fiscal deficit without straightening out the rest of the economic distortions is going to make economic growth something which is very hard to come by.

Accelerating Contraction

According to the Greek National Statistics Office gross domestic product contracted by 0.8 percent in the fourth quarter, significantly more than the 0.5 percent drop forecast in a Reuters survey of economists. The data clearly reveal that Greece's downturn actually picked up speed from a revised 0.5 percent in the third quarter, casting doubt over government estimates of a return to growth in the second part of this year, and raising yet more issues about the evolution of the debt to GDP ratio.

On a year-on-year basis, the economy shrank 2.6 percent in the fourth quarter following a revised fall of 2.5 percent in the third. The sweeping data revision showed Greek GDP contracted by 2 percent in 2009 as a whole, considerably more than the government's earlier 1.2 percent estimate, making for the worst annual performance in nearly 30 years.

The latest batch of data changes only serve to further undermine the government's already badly dented statistical credibility, even if the Greeks are far from being alone in carrying out this type of revision. But it is the scale of the revisions which is so striking in the Greek case - GDP shrank, for example, by a quarter-on-quarter 1 percent in the first quarter of last year: twice the earlier estimate, and the sharpest quarterly contraction since 2005. In the second quarter, GDP fell 0.3 percent, compared with an earlier estimate of a 0.1 percent, while third-quarter GDP shrank 0.5 percent revised from the earlier estimate of 0.4 percent. Rather than leaving the impression that government GDP figures are "doctored" what the revisions suggest is that the government actually has little real idea of what is going on in the economy at any given moment in time, a conclusion I personally find even more disturbing.

The revisions will also push up the figure for Greece’s budget deficit last year, possibly by 0.1 percent, leaving the current "final, final figure" standing at something like 12.8 percent while the debt to GDP ratio may increase 1.2 percentage points to 114.6 percent. But then the Greek Finance Ministry have just amended the 2009 fiscal cash execution data they provide on their website, and have added close to 6 billion Euro to the December expenditure number, making for a final total of 11.8 billion Euro for the month.

This number takes the full-year deficit to 37.9 billionn - up from the 29.4 billion Euro previously reported, with the implication that there will be a further substantial increase in the 2009 central government budget deficit. To date no explanation has been offered for the revision, although a good guess would be it is associated with the payment hospital supply arrears, in which case the general government deficit may well have been proportionately reduced. As I pointed out in this post, even after all the glare of public scrutiny considerable uncertainty still surrounds the 2009 deficit number, and the latest revision is just one more stunning example of the kind of payments changes which one can find made without further explanation. As I say, the biggest doubt here isn't the sincerity of the numbers, but the ability of the government itself to control what actually happens.

Little Relief In Sight

While the current pace of GDP contraction may slow somewhat there is little actual hope for a real and sustainable return to growth in the Greek economy in the forseeable future, and especially as the impact of the fiscal correction starts to bite. Unsurprisingly Greek industrial output continued its fall in December, and was down 2% from November.


And the January PMI suggested that the contraction in industrial output continues and may even be accelerating.

Commenting on the Greece Manufacturing PMI survey data, Gemma Wallace, economist at Markit said:

“The onset of the new year brought little hope of a near-term recovery in Greek manufacturing. Accelerating contractions in new orders, output and employment caused the headline PMI to sink to an eight-month low. Meanwhile, firms were struggling to cover rising costs, as strong competition and unfavourable demand conditions rendered them unable to raise charges.

Domestic demand also shows few signs of life, and retail sales are falling steadily.


As are new car sales.

While Greece has not had the kind of private credit boom that countries like Spain and Ireland have seen (in terms of the levels of indebtedness) credit was increasing at an annual rate of over 20% before the crisis hit, and this boom in borrowing has now clearly run out of steam.

But in fact there was no bubble in house prices in Greece.

And private construction activity (housebuilding) has been falling since 2003.


Nonethless a very substantial current account deficit was created, as the competitiveness of domestic manufacturing industry wilted.

This deficit has been reducing, but both goods and services exports have been falling, so there would seem to be little likelihood at this point of a tourism-driven economic expansion.



Europe's Tough Love May Be More Substantial Than It Seems At First Sight

Rumours still abound regarding the possibility of an eventual EU bailout package. The central scenario still remains the same, namely that money will be made available eventually, as and when needed (probably by end of March), even if the precise mechanism to be used is not yet clear. Speculation continues that the IMF may well play some sort of role, although, again, at this point in time it is far from clear what precise form their participation might take. US economist Jeffery Frankey this week added his name to the long list of those who have now come out in favour of a role for the fund (I have long had my name on the venerable list), and makes at least one novel argument: that core Europe, far from expressing their reservations about a hypothetical IMF role, should in fact be only too happy to welcome one.

Europeans worry that if Greece were put into default, troubles in Portugal and Spain would appear as quickly as heads on a hydra. Perhaps it is glib for an American, on the other side of the Atlantic, to discount the financial strains that Greece is placing on Europe — including Mediterranean contagion, loss of prestige of European institutions, and depreciation of the euro. But in fact it is the northern Europeans who should be most eager for the IMF to come in. They should be the most worried about what they are going to say to Portugal, Spain, Italy and Ireland, if instead they have just bailed out Greece.

Meanwhile the IMF itself continues to wait courteously on the sidelines, limiting itself to stating, as IMF First Deputy Managing Director John Lipsky put it this weekend, that the Fund "is willing to support Greece as thought appropriate by the Greek authorities".

And judging by the latest statements by Greek Prime Minister George Papandreou, thinking is something the Greek administration will be doing a lot of in the coming days, especially after the recent demonstration of "tough love" (lots of words but little tangible support) from their European counterparts. Papandreou reportedly criticised the European Union's response to the country's financial crisis as "timid and too slow" in a televised cabinet meeting in Athens on Friday. He also asserted that the EU lacked coordination, and had effectively undermined Greece's credibility. Speaking on his return from Brussels, Mr Papandreou said that while Greece had received a statement of support, delays and conflicting statements over the past few months had actually served to make matters worse. "But in the battle against the impressions and the psychology of the market, it [the EU response] was at the very least timid, " the BBC report him as saying.

Basically Papandreou's comments are completely out of place, even if they are intended for domestic consumption. It was always unrealistic for Europe's political leaders to agree to more than general guidelines for how a rescue plan might take place at last week's meeting. A firm commitment was virtually impossible, partly because some of the possible solutions - bilateral lending, for example - would very likely have to be approved by the relevant national parliaments, if support was to go anywhere beyond small token sums.

An important list of outstanding issues still need to be decided, including (1) the size of any eventual loan or guarantee; (2) the extent of burden sharing between the other Eurogroup countries (Germany and France are expected to be the heavyweights but others will surely participate as well); (3) the terms of the loan (whether it is only to be short term - 6 months has been mentioned); and (4) the precise terms of conditionality (conditions are expected to be tough, and include specific commitments on what to do if programme execution falls short of estimated objectives.)

Given the complexity of all this, and the amount of fine tuning still to be carried out, it is hardly suprising that nothing substantial was announced, and especially given the fact that the Eurogroup are entering into what effectively consitutes new institutional terrain, while France and Germany, for example, may be very reticent to get too far involved with their Southern neighbours at the cost of loosening ties with - say - the UK and Sweden, which is why Frankel may have a very solid point.

The Planned Correction Simply Is Just Not Doable As Things Stand

Nothing is going to change the fact that if Greece really does tighten fiscal policy by 3 or 4 percentage points of GDP over the next four years, growth is going to be almost non-existent. This is going to be a long hard slog and providing a temporary bridging loan to guarantee Greece’s solvency this year will not avoid the fact that the same will be needed next year, the year after and the year after that.
Societe Generale, The Economic News

As is by now very well known Greece has one of the highest government debt levels as percentage of GDP among the OECD countries. The government’s gross debt burden is expected to rise sharply to 135% in 2012, based on the latest EU Commission projections - up from 99% in 2008. This rise is driven by ongoing fiscal deficits, which hit a minimum of 12.7% in 2009, as a result of the unexpectedly large size of Greece's economic downturn. The deficit is expected to continue to be large in 2011 - as a result of the continuing shortfall in tax revenues. On the government’s own estimates the budget deficit is expected to remain significantly above the EU budget deficit ceiling of 3% until 2012. Thus the Greek government will have substantial borrowing requirements through 2012, with something like €45.2billion gross issuance being needed in 2010 (in addition to the recently issued €8billionn of 5-year GGB’s) and a further €45 billion or so in 2011.



Greece’s Stability and Growth Programme (SGP), which was submitted to the EC on January 14, 2010, is ambitious both in terms of magnitude and given Greece’s track record in fiscal consolidation. The plan aims for a reduction in the fiscal deficit of 10.7 percentage points of GDP over four years, from 12.7% of GDP in 2009, to 2% of GDP in 2013. This magnitude of fiscal consolidation is unprecedented in Europe and raises questions regarding the credibility of the plan - in light of Greece’s poor track record in fiscal consolidation that failed in the past due to lack of political commitment. The plan also assumes a GDP growth rate well in excess of EC and IMF forecasts. According to Dan Lustig (lead analyst in Mitsubishi UFJ's Greece team) who prepared the above chart the plan’s implementation will be "very challenging, given Greece’s large public sector, weak economic growth prospects and the potential for social upheaval, due to the necessity for significant public sector expenditure cuts".


Appendix - A Hard Package To Implement

The main guidelines of the new tax bill and the key themes regarding the Government’s income policy to be introduced into the Parliament for voting in the upcoming days were recently released by the Finance Ministry. These include:

Tax Measures

The upper tax rate of 40% will be applied on annual incomes above €60,000. This will replace the existing €75,000 threshold. The new tax scale implies tax cuts to annual incomes below €40,000 and increases for incomes above this sum. The government have created 6 new
tax brackets for incomes between €12,000 and €60,000, and tax levels will range from 18% to
38%. The progressive character of the tax scale is basically aimed at transferring tax burdens to higher income groups, while alleviating tax burdens from low income categories. Incomes ranging from €12,000 to €16,000 are to be taxed at 18% as compared with the current 24% tax rate on incomes ranging from €12,000 to €30,000. Since around 95% of individual tax records show incomes below €30,000 this implies that low income groups should be less affected by the changes in the tax scale, although it is important to bear in mind that there is probably widespread underreporting of income.

Interestingly the €12,000 tax-free income bracket includes a provision that tax payers need to submit receipts for goods and services in order to qualify. This measure has the objective of helping the tax service crosscheck data and encourages individuals to demand VAT denominated invoices for purchases.

There will be:

- an increase in the fuel tax rate which aims to boost revenues by €934 million in 2010.
- an annual tax rate increase on real estate held by offshore firms (rising to 10% vs. the current 3%).
- A Tremonti type tax amnesty whereby undeclared bank accounts deposits outside Greece can be repatriated at a 5% tax rate for 6 months after the bill is put into effect so long as the money is transferred into 1-year term deposits.
- the introduction of a new progressive tax scale on large real estate holdings valued
above €400,000
- VAT will be applied to a wider category of transactions, and electronic cash registers will be obligatory in an increased number of designated activities (including gas stations, kiosk, taxis, and street markets). Such measures are expected to significantly boost VAT revenues, since many professional activities (like lawyers and doctors) were previously largely exempted from the 19% VAT system.

Regarding the income policy (which will be retroactive and applied to 2010 incomes for employees in the public sector in the widest sense of this term):

- civil servants’ wages will be frozen in 2010, although seniority pay increases will be applied as usual.

- there will be a 10% cut in civil servants’ allowances. Contrary to earlier announcements, the cut in allowances in public sector will not be proportional to the employee’s income (i.e. greater cut for high income groups and lower cut for lower income employees). According to press reports, the decision to apply a uniform 10% cut in allowances across the board was due to the legal impediments to doing it any other way. Nevertheless, the allowance cut, as well as the wage freeze measure, are the key instruments for the government effectively lowering the wage bill of the budget in 2010, in its effort to control government spending.
- As a consequence, the gross monthly income of public sector employees will decline by as much as 5.5%.
- The upper limit for overtime payment is reduced by 30%. - State sector pensioners will get an increase of 1.5%, in line with government’s inflation forecast for 2010 of 1.4%. Pensioners earning more than EUR 2,000 on a monthly basis will get no increase.
- There will be a hiring freeze for the public sector for 2010 (partially excluding the health, education and security sectors), and an application of the rule of 1 replacement for every 5 people who leave from 2011 onwards. Furthermore, a widespread re-allocation of civil servants will be instigated, along with the consolidation of much public enterprise, in order to increase the effectiveness of public administration.

Most of the measures announced were included in the Stability & Growth Programme and are consistent with the government’s earlier announcements.

The Labour Ministry has also announced that it is planning to raise the retirement age as part of changes aimed at amend and support the state-run pension system. The Minister highlighted that unless a reform is implemented the pension system will face serious funding problems by 2015. The proposals which will be sent to the committee of experts and social partners charged with drafting the pension reform bill include the following:

- Increase by 2 years of the effective average retirement age to 63 years of age by 2015.
- Abolishing all incentives to early retirement.
- Encouraging workers to stay on the job longer,
- Separating the health-care and pension systems, with the former being incorporated
into the National Health System.
- Harmonisation of the male and female retirement age in the public sector, in line with
EU directives.
- The establishment of an independent entity overseen by the Central bank to manage social-
security fund reserves.

Greece Gets The Green Light, But Will It All Work?

Well, as reported over the weekend on this blog, the EU Commission did in fact demand "more sacrifices" from the Greek people, and in the end Prime Minister Papandreou had to make a last minute TV appearance to explain to his incredulous listeners that the time had come "to take brave decisions here in Greece just as other countries in Europe have also taken....We all have a debt and duty towards our homeland to work together at this difficult time to protect our economy." I thought that that time had come last November, but evidently I was precipitate in my judgement, but now it has finally arrived, although I ould note that hope does spring eternal, and that even now not everyone is 100% convinced.

When Adreas Papandreou said Greece needed the same brave decisions others have taken I presume he was in fact referring to Latvia, Hungary and Romania.

More than the measures themselves, what is interesting about the Brussels acceptance speech were the series of measures put in place to monitor and control Greek economic policy. As the Financial Times put it, the EU puts Athens under close scrutiny.

"The European Commission, the guardian of Europe’s fiscal rules, struck out into uncharted territory by placing Greece’s economic and budgetary policies under closer surveillance than has yet been applied to a eurozone country."

In fact the European Commission has put Athens on an unprecedentedly short leash, since there is to be a mid-March interim progress report, a further one in mid-May, and quarterly updates thereafter. In addition, an infringement procedure was also launched against Athens for "failing in its duty to report reliable budgetary statistics".

The Commission recommendations will now be forwarded to EU finance ministers for possible approval on 15-16 February. If endorsed, it will be the first time that a eurozone member country will be put under such strict surveillance.

And the agreed measures are obviously far from being the end of the road, since the EU executive only conditionally approved Greece's three-year fiscal plan and warned further cuts in public sector wages would be required (that dreaded internal devaluation) if, as many economists believe, the measures so far announced prove to be insufficient to generate the economic growth which will be needed to meet the steep deficit-reduction targets. Thus the die is cast, and Greece will not, as I recommended, be going to the IMF. Such a move is now seen as superflous, since the EU Commission is steadily transforming itself into a local "mini-version" of the Fund in order to try to handle the cases of those countries who show continuing reluctance in implementing those much needed deep structural reforms. I only hope the Commission have the will to follow this through with all the determination that is needed, since if Greece do now finally go to the IMF for help it will surely now be as an ex-member of the Eurogroup.

Not that this weeks session was entirely accident free. Retiring Economy Commissioner Joaquin Almunia gave yet another example of how clumsy he can at times be, by declaring that "En esos países (Greece, Portugal and Spain), observamos una pérdida constante de competitividad desde que son miembros de la zona euro" (a "continuous" loss of competitiveness), which appeared in the English language press as: "Almunia Says South Europe Has ‘Permanent’ Competitiveness Loss". It isn't clear to me from this distance whether he was speaking in English and his core message got "lost in translation", or whether he thought the speech out in Spanish, and the faux pas is down to his advisers. Either way the damage was done, causing even more problems than needed - according to data from CMA datavision, Credit Default Swaps were up on Spanish Sovereign Debt to 151 bps, or up 18.24 on the day. Portugal CDS also rose sharply on the day - 28.47 bps to 195.80.

As Deutsche Bank's Jim Reid said after the announcement:

Clearly aggressive fiscal tightening can look plausible on paper but the reality is that the path will be full of potential roadblocks. Future strike action will be sign of how prepared the general population is to take the hard medicine. The jury must still be out on this and the market will look to exploit any set backs. However in the short-term the market does seem to have lined up an alternative target.

So the jury still is very much out on just how viable the GDP targets being offered by the Greek government really are. George Papaconstantinou, Greece’s finance minister, may have told the Financial Times that he expected a return to economic growth from the middle of this year - boosted, he said, by strength in the shipping and tourism industries and the “hidden power of consumers” in the shadow economy. But saying this is one thing, and achieving it is another. Growth across Europe will at best be modest this year - let's say between 0.5% to 1% of GDP at the most optimistic - with labour markets week everywhere, so I think it is rather unrealistic to expect a tourist boom going much beyond the one we saw (or didn't see) last year, and the same goes for shipping, which is a sector where surplus capacity still abounds. As for those affluent Greek consumers he is talking about, we have to hope they all dig deep into their wallets, and that each and every one of them now insists on a VAT valid invoice!

But so far there is not much sign of this, and retail sales are actually falling steadily (see chart below). In fact I seriously doubt we are going to see much support from internal consumption at this point. Greece is all about exports now, but where are they going to come from? And how is the country going to get a trade surplus big enough to achieve the sort of economic growth they are talking about without a much stronger internal devaluation?



Industrial output has been falling for some time.



And the latest January PMI only served to underline how Greece was becoming detached from the recovery elsewhere.

Commenting on the Greece Manufacturing PMI survey data, Gemma Wallace, economist at Markit said:

“The onset of the new year brought little hope of a near-term recovery in Greek manufacturing. Accelerating contractions in new orders, output and employment caused the headline PMI to sink to an eight-month low. Meanwhile, firms were struggling to cover rising costs, as strong competition and unfavourable demand conditions rendered them unable to raise charges.

Eurozone unemployment hit 10% for the first time in December, underlining the extent to which the timid economic recovery has yet to translate into job creation. Spain's jobless rate rose to nearly 20%, and Ireland, which like Spain has also been hard hit by a housing downturn, saw its jobless rate climb to 13.3% from 13%. As is normal Eurostat didn't have data on the jobless rate in Greece, where, as Market Watch point out, statistics are notoriously hard to come by. The lastest - EU comparable - number we have is for October, but at this point such a data point is the next best thing to useless. A similar situation exists in the construction sector, we have no clear idea of what is happening since the Greek statistics office simply to not supply comparable data to Eurostat.

Meanwhile the drama in the bond markets looks set to trundle on:

Greece's acute problem is the need to raise financing to allow it to roll over maturing debt in April and May, while preserving sufficient cash to fund current expenditure. We estimate an additional funding need of at least €30bn by May. The concentration of maturing debt is unusual, but even if this immediate source of stress can be overcome, the funding profile for coming years remains demanding. The next three months will have a heavy bearing on the profile that is followed, but whatever happens, Greece and other peripheral euro area countries will still suffer from a chronic need to improve productivity, raise national savings and cut government borrowing.
Christel Aranda-Hassel, Director, European Economics, Credit Suisse.

An all the doubt continue as to whether, with the fiscal retrenchment process and the competitiveness correct Greece can manage to achieve the debt to GDP reductions promised in their Stability Programme. As Credit Suisse's Giovanni Zanni puts it, previously

Nominal GDP growth was systematically higher than the average rate of interest paid on the government’s debt. The implication was that the government could run significant fiscal deficits and still reduce the debt-to- GDP ratio. It did not exploit that advantage significantly, however, and the Greek government’s debt ratio fell only slightly over the period. Things have changed drastically since last year. Nominal growth fell to 0% in 2009. Although it should recover from 2009 lows, we think it will remain subdued relative to the recent past. Even if Greek sovereign credit spreads versus Germany fall back somewhat from the peaks reached last week, it seems extremely unlikely that the favourable dynamics of the past will reappear anytime soon. As such, there are few options open to the government other than to move the primary balance into surplus – a surplus that is sufficient to first stabilise the debt-to-GDP ratio and then push it downwards.

This primary surplus seems a very, very long way off at this point. And Greek bonds fell again yesterday, pushing the premium investors demand to hold 10-year securities instead of German bunds up by 12 basis points to its highest level in a week. The move followed news that Greece’s biggest union had approved a mass strike while tax collectors began a 48-hour walkout. The Greek 10-year yield jumped 8 basis points to 6.76 percent as of 11:45 a.m. in London. The difference in yield, or spread, with benchmark German bunds was at 365 basis points. It widened to 396 basis points on Jan. 28, the most since before the euro’s debut in 1999.



And Citicorp warns that investors may well continue to cut their holdings of Greek bonds amid skepticism the government can overcome public hostility to budget cuts.


“Although Greece has secured the expected backing from the EU for its latest austerity program, we expect markets to remain very fearful of the potential for the fiscal consolidation process to slide or to be derailed by public dissent,” according to Steve Mansell, director of interest-rate strategy at Citigroup in London. Investors, he said, may be “more prone to lighten exposure on any significant spread tightening moves”.

And it isn't only the bank analysts who are not convinced. According to this article in Le Monde IMF head Dominique Strauss Kahn and his close associate Jean Pisani-Ferry, director of the Brussles based think tank Bruegel also have their doubts:

Celui-ci estime que l'UE n'a ni la vocation, ni les équipes, ni les techniques pour analyser les carences d'un pays et préconiser des remèdes. L'Union n'a pas l'habitude d'affronter l'impopularité des thérapies de choc et pourrait céder aux manifestations de rue. Le FMI peut jouer de sa réputation de dureté pour aider le gouvernement grec à imposer les sacrifices inévitables.

Which in plain English says that they thing the EU Commission has neither the vocation, nor the teams, nor the technical experience to take on a job of this size, and while it is vital that the necessary structures and policy tools are developed, in the meantime the clock is ticking away, and the infection is spreading to the Sovereign Debt of other countries - even as far away as Japan. Basically M. Strauss Kahn seems to feel that the EU Commission is assuming an unnecessarily high risk, and that the Greek dossier should really have been sent to the IMF as a matter of some urgency. I cannot but agree.