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THE SOVEREIGN DEBT DEBATE THE CASE OF GREECE

THE SOVEREIGN DEBT DEBATE THE CASE OF GREECE. Presentation to International Consulting Economists’ Association by Costas S. Mitropoulos Executive Chairman. THE KEY MESSAGES.

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THE SOVEREIGN DEBT DEBATE THE CASE OF GREECE

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  1. THE SOVEREIGN DEBT DEBATE THE CASE OF GREECE Presentation to International Consulting Economists’ Association by Costas S. Mitropoulos Executive Chairman

  2. THE KEY MESSAGES • The international financial crisis, through the worsening of the economic environment, gave the final push to certain countries to enter crisis • EU, as a loose federation has not been able to comprehend and respond fast to the problems of its weaker and stronger members • Greece under the weight of the wrong dynamics was unable to provide any resistance to the pressures of the time • The default of Greece is to no one’s interest (bond holders, Greece or any other third party) • Debt looms heavy above Greek heads, yet it is manageable • There is a way forward and out of the crisis; fiscal discipline, debt management, improved competitiveness, and significant investment • A number of measures have been implemented by the Greek government, with many more in the pipeline • There are lessons for all countries from the crisis; chief amongst them is that states should be run as corporates

  3. 1. THE BACKDROP Crisis revealed the cracks • Perceived risks (e.g. sovereign, counterparty, credit) increased across the board and thus risk premia • World growth decelerated and world trade fell even more in 2009 • Fiscal and monetary policies eased (e.g. QE 1.2.3.) with significant rise in government debt Source: Bloomberg Δ(Debt/GDP): 2007 2011 Debt/GDP (2011) Source: AMECO • The divide between emerging economies growth (BRICs) and developed economies growth opened up (G-20 reflects the political shift) • Swift capital moves, catalysed by rating agencies and global banks, accentuated

  4. 2. THE EU IN THE CRISIS A dual personality • EU is a loose federation of countries and it is perceived so • EU as a single country is probably the strongest economy on the planet • The Euro is the second largest reserve currency in the world (USD 61%, EUR 27%) • EU countries debt is being held within the EU (60%) • The three economies under debt pressure (Greece, Ireland, Portugal) account only for: • 4.6% of EU GDP • 6.4% of EU debt • Yet the considerable performance variance amongst countries and the lack of unified fiscal policy have led to a perception of danger for the EU and the Euro

  5. 2. THE EU IN THE CRISIS Two speed Europe – Reality and .... TWIN SURPLUSES Source: AMECO IE, ES: No fiscal problem but real estate bubble and over-extended banks IE, ES: No fiscal problem but real estate bubble and over-extended banks TWIN DEFICITS • Current account deficits: Caused by excessive optimism, leverage and consumption • Fiscal deficits: Government money was channeled to consumption rather than investment

  6. 2. THE EU IN THE CRISIS Two speed Europe – ………. and Market Perception Junk status

  7. 2. THE EU IN THE CRISIS Different countries, different problems • IRELAND • Housing market • Banks → public debt ↑ • High private debt • PORTUGAL • Low competitiveness • Large fiscal deficits • High private debt • SPAIN • Low competitiveness • Housing market • High private debt • GREECE • Low competitiveness • High fiscal deficits • High public debt Sum of Public and Private Debt 2010 (ΕΕ-16, % ΑΕΠ)

  8. 2. THE EU IN THE CRISIS Policy response within EMU – Late and ad hoc

  9. 2. THE EU IN THE CRISIS The new policy initiatives will lead to a gradual harmonisation of fiscal policy • Adoption of Competitiveness Pack • Tighter political management of individual countries fiscal policies: • Excessive Deficit Procedure • Annual Budget Veto • Creation of permanent European Stability Mechanism • E-bonds for up to 40% or 60% of individual country GDP • ECB to provide liquidity to Eurozone

  10. 3. GREECE – DEBT AND DISTORTION A closed, service based economy driven by consumption and fuelled by debt

  11. 3. GREECE – DEBT AND DISTORTION A country driven by consumption and ….. y = 39.55-0.55 x R2 = 0.29 Source: AMECO (Private plus Pubic Consumption)

  12. 3. GREECE – DEBT AND DISTORTION ……and fuelled by debt

  13. 3. GREECE – DEBT AND DISTORTION A story of fiscal mismanagement Source: European Commission, Spring 2010 forecasts Greece GAP = 3.1% Entry to the Euro • Greece increased revenues prior to joining EMU • Expenditure kept below 45% GDP prior to 2008 • 2008 deterioration despite real growth of 1.3%

  14. 3. GREECE – DEBT AND DISTORTION Greek banks are in good shape, though with limited liquidity Banking Sector Assets, % GDP (December 2010) • The Greek banking sector is small, with assets accounting for 223% of GDP • Greek banks did not cause the problem, like with Ireland, Iceland or even the US • Greek banks are strongly capitalized (CAD ratio at 11.2%, Tier I at 10.2%); easily passed recent stress tests with a single exception (ABG) • Greek banks borrowed in the wholesale market to finance expansion abroad; domestic banking system is deposit rich (L/D 93% for banking groups); • Asset quality worries seem overblown (NPLs at 10%); Greek private sector is not over-leveraged; pre-provision margins 40% wider than EU; absence of toxic assets and no real estate bubble • Substantial CEE/SEE exposure offsets Greek strain as profits to track regional economic recovery; region represents 35% of total lending for the four large Greek banks and corresponds to c.a. 40% of total revenues • Liquidity (now over 20% of deposits) is limited but systematically boosted (covered bonds, government’s liquidity scheme, ECB) New Europe Return On Assets Source: ECB, BoG

  15. 3. GREECE – DEBT AND DISTORTION Should Greece default – Probably not…… • A Greek default will be an EMU rather than a Greek decision • GGBs are primarily held by Greek and other EMU members financial institution, which clearly do not want Greece to default • Greek banks own approximately €57 bn, pension and other funds another €25bn, individuals around €15bn. A haircut would force a bail out of the banking sector and the pension system • EMU banks hold a major chunk of GGBs, most of it posted at the ECB as collateral. There will be no benefit to these institutions from a Greek default • The ECB holds significant amounts of GGBs both directly (~ €50 bn) and in the form of collateral (~97bn). Again there is not interest in a haircut, despite the fact that GGBs purchased through market operations already carry a discount • EMU countries have given €80 bn in loans (with IMF €30 bn) on which Greece cannot default • The risks of contagion post default within the European financial sector are significant • A first for Euro default, will have an adverse impact on the currency • A deposit run in Greece during the default/restructuring process, plus inability to tap the markets for a long time after the default will undermine completely the economy • Post default Interest costs will increase significantly for the Greek private sector as well, further constraining growth

  16. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Four components • Fiscal discipline, tax collection improvement and central government expenses tidying up to lead to primary surpluses • Debt management,including debt rescheduling, debt repurchasing and debt retirement through privatisations • Long term competitiveness improvement: • salary compression (public and private sector) • structural reforms (e.g. labour market, pensions, market liberalisation, education) • privatisations • reduction of central government • Boot strapping through investment, as it is mainly a closed economy: • €65bn infrastructure investment, in the main through concessions • exports increase will lead to new investments • capital mobilisation by the private sector (EU funds and private funds)

  17. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Specific Policy Measures Lead time to max impact • New fiscal framework • Salary reductions in public sector • Pension reductions • Debt management Critical Short • Privatisations • State expenses reduction • Tax collections improvements • Private Investments • PPPs/Infrastructure Investments • Labour market reform Long • Pension system reform • Professions market reforms Growth locos Impact Low High Necessary but not sufficient

  18. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Fiscal reforms by the government are drastic and continue … • “Kalikrates” Law adopted in June, reforming public administration at the local level, reducing the number of municipalities from 1034 to 325, and dissolving 54 prefectures • New Financial Management Law (NFML) adopted on July 29, 2010, amended the budget process: • 3-year fiscal strategy (by end of March 2011 the first three year budget plan for the 2012-2014 period is expected according with the revised MoU) • top-down budgeting with explicit ceilings for state budgets and expenditure estimates by line ministries • standard contingency margins, commitment controls, supplementary budget for overspending • commitment to register and publish monthly data on General Government, and to report all arrears monthly • The 2011 Budget was formulated according with the NFML • Single Payment Authority becomes gradually operational for Central Government and in March for General Government • Independence of the Statistical Agency established on December 2009 and new regulations for Statistical Action Plan

  19. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD ……. with more reforms to come • “Fast track” law for investments, focusing on FDI’s voted by Parliament • Liberalization of the road freight transport already voted by Parliament • Reform of the public sector enterprises, voted by Parliament • Restructuring of railroads, voted by Parliament • The opening up of the closed professions, voted by Parliament • Further reforms of the tax legislation in order to fight tax evasion (Centralization of data collection, dedicated task forces focused on high-income earners and firms, centralized taxpayer service directorate, centralization of enforcement and other medium term measures) • Competitiveness and business environment measures (business start-ups, adoption of the services directive etc.) • Review and simplification of public sector remuneration • New investment law • Auditing of hospitals (currently 10 largest being audited by PWC) • Further implementation of the health care reform • Implementation of business start-up law (general electronic commercial registry, one stop shops for start ups etc) • Strengthening the independence of the Hellenic Competition Committee

  20. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Tax collection - Signs of improvement VAT revenue and domestic demand

  21. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Tax collection – But there is significant room for improvement VAT revenues as % of private consumption (avg. 2000-2009) PIT revenues as % of GDP (avg. 2000-2009) The size of shadow economy (% GDP) • Measures combating tax evasion (broadening the VAT rate, linking household tax obligations to living standards, forcing households to show the means of having accumulated visible wealth) • Abolishment of exemptions and special tax regimes, and simplification of tax structures • Rebalance of current tax rates (VAT, PIT, other) so as to strengthen the non-evasion incentives

  22. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD More debt will be required … Required issuance of marketable government debt

  23. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD … but all debt can theoretically be serviced € bn Debt Servicing Capacity: Government net revenue vs. interest payments (EUR bn) (Net revenue=revenue-public wages-social transfers • To be serviceable debt needs to be redeployed over a far longer horizon • The lenders of last resort (EU/ECB/IMF) should work with all bondholders to reschedule debt in its totality • Interest rate is an important factor in servicing debt at the envisaged levels of primary surplus (1pp ~ 3.5bn)

  24. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Debt must be lowered and managed with the assistance of EU • Current debt at €330bn will be raised to €360bn by 2014 • Privatisations may yield ca €15bn in the period to 2014 which will be used to retire debt • Purchasing of discounted GGB from the market and ECB could retire another €30bn of debt • Such measures will take out ca 15% of the debt and equivalent percentage points form the Debt/GDP ratio • Rescheduling of the remaining debt of ca €315bn, (€110 EU/ECB/IMF and €215bn on the market), so as to be fully serviseable over a longer time horizon • Primary surpluses should not only be sufficient to service the rescheduled debt, but could occassionaly used for early repayments

  25. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Real wages are declining Real compensation per employee (%, y-o-y, total economy) Source: European Commission, EFG Research projections for 2010 • Real wages increased in EA-16 by 2%, hence difference of 10% • Real wages projected to decline further in 2011-12 due to labor market reforms and their impact on the private sector, plus public sector wage restraint • Positive catalyst for exports over next few years

  26. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Structural reforms will boost growth potential • Labour and product market reforms: • IOBE (2010): increase of GDP by 17% from structural reforms • EU-Commission (2010) estimates that a permanent real wage cut of 1% leads to a 4% increase in GDP in four years • A decline in price mark-up of firms by 5% leads to a 2.5% increase in GDP in five years • A reduction in GGB spreads by 100 bps has an immediate impact of 1.5% of GDP in the same year • Crowding-in of the shrinking public sector • Capturing the underground economy (25-30% of GDP) will most likely improve efficiency, not only statistics

  27. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Privatisations and public/private partnerships may generate €15bn by 2014  Water Management Athens Water Supply and Sewerage Company Thessaloniki Water Supply and Sewerage Company  Gaming OPAP (sale of 34% stake) Casinos (sale of Casino of Parnitha, Athens) Internet Gaming, Electronic Games Lotteries (strategic investor, sale of stake through Athens Stock Exchange) ODIE-Horse races (strategic investor)  Real Estate Hellenic Public Real Estate Corporation Hellenic Tourism Development Corporation Olympic Properties Railways Real Estate Endowments Real Estate managed by Ministries Old Athens Airport (SPV established, interest by QATAR) • Banks • Agricultural Bank (restructuring) • Hellenic Postbank • Hellenic Consignment and Loan Fund • Attica Bank • Infrastructure, Transport and Telecoms • Athens International Airport (sale of 55% stake) • Regional airports (concessions) • Railways (sale of commercial business) • Motorways (concessions) • Postal Service (strategic investor) • Spectrum Frequencies (sale of licenses) • Energy • Public Power Corporation (give access to lignite reserves to private operators) • DEPA (sale of stake) • Hellenic Petroleum (possible sale of stake) • Ports • Piraeus Port Authority (to merge with all Attica ports) • Thessaloniki Port Authority (concessions) • Regional 10 Port Authorities (concessions) • Marinas (privatization)

  28. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Exports contribute to growth • Imports had a positive impact in 2009 and in 2010 as they fell in both years (by a total of 30%). • Imports expected to decline further in 2011 due to falling domestic demand. • Exports expected to increase significantly in 2011 due to: • High correlation with global trade (correlation = 90%) • real wage cuts and improvement of competitiveness (2010: ~6.0%) • merchandise exports up 25% yoy in first two months of 2011 Source: IMF DOTS, Eurobank EFG Research

  29. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD There is room for investment with high returns • Capital is the key driver of growth • Greece has a lower capital intensity and higher returns on capital, compared to the EU average • Return on capital in Greece systematically higher than in EA-12, suggesting incentives to invest • Investment can pick up the moment market conditions normalize; funding will be supplemented with EC funds Capital Intensity Net Returns on Net Capital Stock (2000=100) Net capital stock at 2000 prices per person employed (1000 €) Source: AMECO Source: AMECO

  30. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD Investments in infrastructure could amount to €65bn in the period to 2016

  31. Fiscal Discipline • Debt Management • Long term Competitiveness • Boot strapping through investments 4. THE WAY FORWARD The latest adjustment programme …. and some sensitivities Assumptions Sensitivity analysis Source: Revised EU/IMF/ECB adjustment programme

  32. 5. LESSONS FROM THE DEBT CRISIS • For a country to enter into a crisis there would have been more than one economic deformities: • To manage any reform process the political management must: • have clarity of purpose • demonstrate clarity of process • muster significant project management capacities • focus on pulling critical levers rather than on quick wins • be able to mobilise capital as well as human resources • establish credibility against third parties from the early stages • Exceedingly large state debt is the tumor that suppresses recovery: • reducing it early on, enhances credibility and strengthens the notion of control • repaying it demands rescheduling and a systematically growing economy • managing it requires all bond holders, under the guidance of an agent (EU) to agree on new schedule subject to structural and fiscal reform covenants • Crises are fed by the prevailing culture and perceptions. Altering them fast is of paramount importance to exiting • To minimise the likelihood of future crises, and contrary to widely held political beliefs, the state should be run as a corporate with proper P&L and Balance Sheet (NZ has already done it) • A question remains that time will answer; a closed economy like Greece or an open one like Ireland will get out of the crisis faster Greece Ireland • High private debt • Economic bubbles (e.g. real estate) • Wrong first reaction • Persistently high consumption • Persistently high public debt • Fiscal mismanagement 2007-2009

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