Posts tagged ‘sovereign crisis’
With August almost upon us the summer lull is well underway. The FTSE 100 index has drifted along in a 100 point range over the past three weeks; volatility has also fallen away in the US and European stock markets; sterling seems to have found a stable level in the wake of its Brexit-driven devaluation; and yields on the major bond markets, including the gilt market, have found their lows for now. The oil price has fallen back again – the near Brent crude contract has been testing $42 per barrel today, down from over $50 at the start of the month – but aside from that there has been little to report.
There is a chance that could change next week. After the US close today, the European Banking Authority will publish the results of its latest “stress test” for the EU’s largest banks. There has been a lot of focus on the problems in the Italian banking sector: bad loans in Italy have been estimated to amount to €360bn, or about 22% of the country’s GDP. Indeed, when the EBA ran its last test in 2014 the worst-placed institution was found to be Banca Monte dei Paschi di Siena, and an emergency capital raise was required as a result.
This time round statements to the media suggest there are unlikely to be any nasty surprises. European banks have already underperformed the market this year, first of all during the Febrary panic and then in the aftermath of the UK referendum, so a lot of pessimism has been priced in to the sector. And at the stock specific level, the weaker institutions have already suffered severely: BMPS shares have fallen by more than 80% over the past 12 months. Deutsche Bank, another focus for concern, has seen its share price fall by almost 60% over the same period. In fact there may even be value in ending some of the uncertainty in this area. We shall see.
What we know already, however, is that national banking systems rely ultimately on state support in times of crisis. Should there be systemic failure in Italy, or elsewhere, it would fall to national governments to control the damage via bailouts, managed insolvencies with “bad bank” spinoffs and so on. Those governments rely in turn on their sovereign balance sheets. That is better news for some countries than for others: Greece, on the one hand, is in no position to bail out Athenian lenders, while Germany, on the other, could stand credibly behind its banking system if required to do so. So what do those balance sheets look like, compared to the recent past? Which of the world’s largest economies should be able to withstand further shocks to their financial systems, and which of them are probably too deeply indebted to manage it?
Budget Deficit / Surplus % of GDP: pre-crisis, mid-crisis and post-crisis
Gross Government Debt % of GDP: pre-crisis, mid-crisis and post-crisis
This data is sourced from various government agencies and central banks. While there is a certain amount of methodological variety at play the key points are fairly obvious.
Looking at the data on national debt burdens first, it is plain that most developed nations are appallingly badly placed to weather a fiscal storm arising from another financial crisis, or indeed from any other source. The exceptions are (predictably) Germany, and (to a lesser extent) the UK. The one bright spot comes from the bond markets: with interest rates so low in all these nations the burden of servicing their debts is relatively undemanding. In fact Chancellor Hammond may well find he has some limited scope for fiscal loosening come the Autumn Statement if rates stay at their current levels.
Staying in the developed world and turning to the budget deficit data, the eurozone as a whole looks pretty healthy, as does the US. At the national level, however, there are of course some terrible problems. With its shrunken GDP and hefty deficits the burden of Greek debt is now higher than it was prior to the restructuring of 2012. In Italy the budget deficit is actually quite modest now, but that hasn’t helped reduce the country’s debt burden because of its low growth: the Italian economy is 8.5% smaller in real terms than it was in early 2008. This has fed the bad loan problem in the country’s banking system while eroding what ability it has had to manage any serious shock.
Away from Europe, Japan’s balance sheet has exhibited eye-watering deterioration. The postponed sales tax increase there is due next April. This may drive growth down again but it is unlikely to improve the country’s fiscal metrics much. It is true that Japan’s net government debt position is not quite so bad (128% of GDP on the IMF’s estimate for 2015; China’s net sovereign debt position is also greatly reduced at 17%). But with debt at these levels, population decline and (this year) a strong yen the prospects for this quondam global powerhouse remain sclerotic at best.
Brazil, which was downgraded to junk over the period from last September to February by the Big Three rating companies, has suffered economic strife in recent years. Compare its fortunes to those of India, where growth has seen the debt burden shrink even as moderate fiscal deficits have persisted. To end on a positive note it is remarkable how well Russia has managed to cope with the collapse in oil. The days of 7% budget surpluses might be long gone but there is little debt to speak of – and not much of a deficit either.
The numbers here will in many cases take years to improve. In Japan’s case it is not clear how they might be improved at all. Many countries simply cannot afford a national emergency, and will find their fiscal planning easily destabilized by movements in interest rates. Depending on the outcome of the EBA’s analysis tonight there may be one or two European countries very grateful for the backstop represented by the ECB’s ability to intervene in bond markets this weekend.
This week saw headlines appear about the possibility of another debt crisis in Greece. A multi-billion loan repayment to the ECB is due this summer; the European Commission and the IMF – the other two members of the “troika” governing the bailout arrangement – are divided on the scale of deficit reduction required to allow funds to be released; and in the meantime the country has just gone out on a general strike today in protest at any further “austerity”.
It feels, rather sadly, just like old times.
Yet things have changed in Greece since the pandemonium over her original bailout and debt restructuring. The governing leftist coalition, Syriza, has learned through bitter experience that it really does have no option but to comply with its creditors’ requests. And while books will doubtless continue to be written on the fiscal consolidation undergone by western countries since the Great Recession it is undeniable that Greece has been getting on with the job: the budget deficit there, as a proportion of GDP, has been falling from its 2009 peak of -15.2% at almost twice the pace at which it had grown during the course of Greece’s eurozone membership up to that point. This has had the effect of containing the national debt to GDP ratio, which while eye-wateringly high (177% for 2015) has fallen since 2014 despite the suffering brought about as a result of the Greek government’s hubris a year ago. Indeed, take out the effect of the debt restructuring in 2012 and last year’s fall in this ratio was the first since 2007.
There were also tentative signs of recuperation on the broader economic front too. The European Commission’s spring economic forecast was published on Tuesday and the expected contraction in Greek GDP this year was revised down from -0.7% to -0.3%. (Growth of +2.7% is projected for 2017.) The slow turnaround in employment might have halted for now, stuck between 24%-25% over the nine months to January, but with growth beginning to return again this should continue to tick down – and remains below the peak of 28% reached three years ago.
In the meantime, bond markets in Greece and elsewhere on the eurozone periphery are not showing any sign of panic. Ten year Greek government paper is trading down towards its lows for the year to date (just over 8% at present), well short of the over 11% reached during February’s market-wide funk. Italian and Spanish bonds have been priced around the 1.5% mark in recent weeks, just like ten year gilts.
It is worth reflecting that five short years ago – when many respected commentators were confidently predicting the demise of the euro – this was unthinkable. Greece might have been in the headlines again but there is absolutely no contagion in evidence today. Today, markets are not even bothering to try taking on Mr Draghi and his “bazooka”.
It is also worth reflecting that economic growth in the eurozone as a whole is projected at +1.6% this year and +1.7% next – a breakneck pace compared to the average rate of +0.9% over the last 15 years. And talking of headlines, it drew some attention last week when data emerged to show that the zone’s GDP had finally surpassed its pre-Great Recession peak in real terms. Numbers out last month showed its deficit falling as a percentage of GDP for the sixth consecutive year in 2015 to -2.1%, and confirmed that total debt to GDP peaked a year earlier. The unemployment rate might already have dropped back below 10% this month for the first time since April 2011.
There are political risks ahead for Europe but to say that the eurozone as a whole has moved on from the debt crisis is beginning to look like an understatement. It is to be hoped that Greece manages to continue her recuperation. If she does so the “European debt crisis” will soon be history.
The continued negotiations over emergency lending to Greece have been an obvious political risk for some time, and one which increased with the change of government there in January. This week’s leading stories have been dominated by the latest down-to-the-wire developments. The shock deferral of a payment due to the IMF until the end of the month was followed by recriminations between the Greek government and its creditors at the highest political level and the IMF team itself has now stormed off from Brussels in despair: EU Prepares For Worst As Greece Drives Finances To Brink (Bloomberg)
We have already looked at the possible consequences, and certain pain, that would ensue following a Greek sovereign default (The Joy Of Negotiating). In any case an indebted Greece would still require emergency funding of some kind in the aftermath of such a default as the bond market would be closed. Its emergency creditors would likely be exactly the same bunch it is dealing with today, or wild card lenders like Russia or China who on the evidence of previous discussions would require security over the nation’s land or other assets that even Greece’s previous government was unwilling to consider.
The Greek public appears to be more alive to the reality of their situation than their government. According to a poll conducted at the beginning of the month, 47 percent disapprove of its brinkmanship (and 74 percent want Greece to remain in the euro).
Even as time truly begins to run out, however, markets are still relatively sanguine about the possibility of default. Peripheral country bond spreads to Germany have widened a bit but remain below levels reached last summer, before Greece resurfaced as an issue. The euro is 3% up on the month to date. Equity markets have shown some nerves but there have been absolutely no signs of panic in the pricing of haven assets such as US Treasuries or gold. This is nothing more than reasonable: Greece is a small economy (GDP of $242bn in 2013 on World Bank numbers, less than 2% of the eurozone total), so the level of contagion occurring naturally from its collapse would be relatively muted.
Which brings us on to the real tragedy of these negotiations: the effect they are having on Greece. Economic sentiment has withered back towards the level it occupied during the final quarters of the country’s last recession in 2013. The banking system has been weakened – again – by the offshoring of deposits. Another recession is guaranteed. This is doubly disastrous when one considers that the budget deficit last year, at €6.4bn, was its lowest since 2000 and down from a peak of €36.2b in 2009. The country had exited recession, was running a primary surplus, meeting its debt obligations and seeing the number of unemployed decline for the first time since 2008. That has all been thrown away. Only yesterday employment data showed that the economy has gone back to shedding jobs. And in a year when European growth and consumer spending have been picking up notably and the currency is internationally weak, Greece’s key tourism industry might well have been expected to put on its strongest showing since the financial crisis. It would be astounding if the heightened uncertainty and bad press arising from the government’s actions have not turned many of those tourists away now.
The bottom line is that Greece needs its credit lines more than its creditors need to spend time playing games with the Greek government. The question the members of that government ought to be asking themselves, again and again, is: who benefits?
Let us leave the last word to an economist quoted in this post’s first linked article:
“People are really fed up with this,” UniCredit SpA Chief Global Economist Erik Nielsen said in a television interview. “They’ve never seen anything so completely ridiculous, frankly speaking, from a debtor country.”
While they may not yet be making headlines across the broader media as in days gone by, the ongoing negotiations between Greece and her creditors are the subject of the most widely-read article on Bloomberg today. Entitled German-Led Bloc Willing To Let Greece Leave Euro, the piece has the following money quote from Edward Scicluna, finance minister of Malta:
Germany, the Netherlands and others will be hard and they will insist that Greece repays back the solidarity shown by the member states by respecting the conditions … They’ve now reached a point where they will tell Greece ‘if you really want to leave, leave.’
It is now nearly five years since the downgrade of Greek debt caused worldwide panic over the condition of Europe’s sovereign balance sheets, and for much of that time there have been some who have advocated euro withdrawal and default as the solution to the country’s problems. Somewhere near the zenith of this view’s popularity readers may remember that it was Titanically flawed:
First of all, the currency … There would be rapid depreciation – indeed, the possibility that [it] could cease to be transferable internationally. (The Icelandic krone threatened this at the nadir of the recent crisis with the result that the supply of imported food was jeopardized.) Even if the drachma were tradeable, immediate, rapid inflation would occur. At the same time, bank deposits and other assets would have to be re-denominated, decimating the wealth of the nation overnight. These twin effects would demolish household and business consumption and consign the country to a further period of sharp economic contraction.
All well and good, say the defaultists. But at least Greece would be free of her debt!
Yes, and no. Greece is still running a budget deficit and in the catastrophe scenario this would get worse. So unless the Greeks wanted total state shutdown, they would still have to borrow money. Who would be the lenders? The EU; the IMF: exactly the same people who are lending to them at the moment. The conditions imposed by those lenders – who would still have effective control of the country’s economy until their loans were repaid – would be at least as punitive as the conditions they’re imposing now. In other words, there would be at least as much austerity to contend with, and possibly more.
One key feature of the economic landscape has changed since then, however: Greece has been running a primary budget surplus since the middle of 2013. This means that, ignoring debt interest, the government is raising more in tax than it spends. The last available data from the Bank of Greece (for November) has this primary surplus running at 2% of GDP. There are suspicions that the position has deteriorated since, but the key point is that – in theory – the Greek government could walk away from its debt and let its creditors go hang as it would no longer need to borrow money.
Bearing in mind the point about the currency, banking system and the rest, this surplus would likely not last very long in the event of a “Grexit”, so it isn’t that strong a negotiating point. It does, however, make such a decision appear less obviously stupid. This might well reduce the extent to which political will is bent to economic fear. The Greek situation today is therefore arguably more volatile than it was in 2011.
This is certainly not how it seems. The market reaction to Syriza’s election and Greece’s return to the repetitive circus of down-to-the-wire debt talks every few months has been pretty muted. The country’s ten year debt is priced at over 60 cents on the dollar, below the 80 cent level reached before last autumn but nowhere near reflective of the 74% loss incurred by bondholders in the 2012 restructuring. The Athens Stock Exchange index has fallen 24% over the past six months, but that is pretty tame compared to the 69% fall it suffered over calendar 2010 and ’11 – and it is actually some 3% up on the year to date.
The overall market view, then, seems to be either that the current talks are nothing to worry about, or that Grexit doesn’t matter very much. And besides, the Euro Stoxx 50 is up 11% since the end of 2014, last week’s GDP data for the eurozone was a little ahead of expectations, today’s stronger-than-forecast PMI numbers suggested the outlook here remains bright, and while it has bounced a bit recently the oil price remains about 45% lower than where it spent the first half of 2014. (If you add up the individual members you find that the eurozone, not the US or China, is the world’s biggest oil importer by some distance.)
It appears highly unlikely that another major debt restructuring is on the cards for Greece (as opposed to changes to its existing terms). On this basis the relatively sanguine market view looks right. Prime Minister Tsipras could of course decide to give the world a shock, but it remains clear on balance that this wouldn’t do his country much good.
A while ago, we looked at the re-entry of Greece into the bond market and noted that it could mark the beginning of the end of the sovereign debt crisis. This week, new borrowing figures for the UK reminded us how big a millstone borrowing can be around a country’s neck
The government is borrowing more this fiscal year than it did last time. This was not supposed to happen: the economy is growing at a fair lick, unemployment is falling, welfare spending and public sector pay has been capped and so on. Reasons for the disappointing outcome include weak earnings growth, a slower-than-expected housing market and the lower oil price. (It is worth observing that real wage compression in particular has been a persistent affliction here in Britain, with inflation-adjusted wages at the whole economy level almost 10% lower today than they were five years ago.)
It is still likely that our debt to GDP will peak in the next three years or so and gradually climb down below 90% again (on a Maastricht basis). But even at this level, and with very low rates, interest payments for 2015-16 are forecast at £59bn – more than the education budget and about 8% of total government spending.
Of course Britain is not alone in this position. Look around the developed world and sovereign balance sheets are, as a rule, stretched. The increase in US debt to GDP, which saw it rise from 63% in 2007 to over 100% five years later, has levelled off, but in money terms the country owes the staggering sum of $17.9trn. For the American fiscal year just ended, interest on this debt amounted to just under $431bn. That is getting on for an eighth of the Federal budget.
Eurozone debt was 90.9% of GDP last year and it still likely to rise with growth in the economy as anaemic as it is. In Japan, debt to GDP stands at over 210%, and last year the Japanese were still running a massive budget deficit (over 9%). Controlling this has consequences, as we saw earlier in the year when the sales tax increase came in and shrank the economy.
Japan is an interesting case for another reason, however. It is one of the world’s largest holders of reserve assets, with some $1.2trn in the bank. Only China has more (almost $4trn). Another country with huge reserves relative to GDP is Saudi Arabia, with $735bn worth against total output last year of $745bn. Neither China nor Saudi have a material level of sovereign debt (22% and 12% of GDP respectively).
Some of the results of this situation are obvious. On the one hand, highly indebted nations will spend many years paying huge amounts of interest and struggling to grow their way to more manageable debt positions. On the other, those nations with little debt and healthy reserves will profit from the interest payments. China owns about $1.3trn of US government debt. If this reflected the market as a whole the average coupon would be around 2.5%, so Uncle Sam would be paying the Chinese $32.5bn per year.
More interesting, perhaps, are the less obvious effects. It might come as a surprise but Saudi Arabia increased production of oil by 50,000 barrels a day last month. The IMF estimates that the Kingdom requires a price of $83.60 per barrel to balance its budget, which is about where oil is at the moment, but with no debt to speak of and huge reserves the Saudis can manage a few years of low prices. After all, their oil is still very profitable to extract at this level. And if it hurts the competition in Russia, poses a distant threat to shale exploitation in the US and possibly destabilizes Iran, it seems unlikely that Saudi Arabia will mind very much.
The global debt position has changed the balance of economic power. In addition to political consequences there have been and inevitably will be consequences for markets, not all of which will be intuitive. Finally, it is rather gloomy to reflect that the UK is not among the stronger nations on any measure now: our high debt ratio is accompanied by lower reserve assets than Poland and less gold than Venezuela.
Europe has been much in the news again lately. David Cameron expressed a preference for the Presidency of the European Commission to go to an unknown arch-federalist other than the one seemingly favoured by his fellow leaders. This is exciting enough. But a wiretapping scandal in Poland, which initially passed unnoticed when as a purely local matter it threatened only to unseat the governor of the Polish central bank and plunge the ruling party there into crisis, is more exciting still. According a magazine report, foreign minister Radosław Sikorski – who to top things off was once a member of the Bullingdon Club – has, in the even-handed vocabulary of the BBC, “criticised UK Prime Minister David Cameron’s handling of EU affairs”:
He goes on to say, using expletive-laden terms, that Mr Cameron messed up the 2011 EU fiscal compact on budget discipline, which the UK tried to block. “Because he’s not interested, because he doesn’t get it, because he believes in this stupid propaganda, he stupidly tries to manipulate the system,” Mr Sikorski was quoted as saying.
Readers might well have forgotten that the fiscal compact of which Mr Sikorski speaks began life as a putative new EU treaty, which Britain vetoed in December 2011. It subsequently took off as a “compact” between every EU member state except the UK and the Czech Republic – though the Czechs are due to sign up any minute now if their new leader has his way. Once again, Britain looks destined to stand alone, etc.
Whether or not we forget about it, however, Europe marches on. While it has not received any attention, the fiscal compact has been making and is set to make further advances. The budget rules and submission timeline agreed back in 2011/12 have already swung into action: last October saw the first occasion on which every nation signatory to the compact had to present its annual budget to the Commission for scrutiny. And from 1 November this year, prudential supervision of financial institutions in all signatory countries – not just eurozone members – will become the prerogative of the ECB.
It is traditional to interpret the plenipotence of Brussels from a position of coyness. For example, the fiscal compact sets the Commission up with the same sort of mandate as the OBR here in Britain: a dispassionate and final compiler of economic data for national budgets. Yet EU member states still possess every freedom to come up with their own data (in some areas, for now). This is why Spain was able to dismiss the EU’s concerns over its budget this year as “a mere difference in growth forecasts”, and proudly plead that deficit targets would, nonetheless, be met. For Italy, facing similar concerns, the answer was even simpler. By the time this year’s budget had received Commission feedback the country had already decided – quite independently – to privatise a few more state assets, thereby meeting its solvency targets while not bowing to usurpation of fiscal policy at all.
It is at times like these that one can become grateful for England’s generous allocation under the Common Humour Policy. But for those taking a medium term view of European affairs and Britain’s continued involvement with them there are three very serious points to take on board.
- The sovereign debt crisis for Europe in particular was / is a defining moment in its history: the goal of “ever closer union” became not just a political ideal but an imperative of economic survival.
- The United Kingdom benefited throughout the crisis – however irrationally – from having decided to remain outside the euro.
- The UK view on the necessity of “ever closer union” has thus diverged ever more markedly from the views of other EU states, and those of the euro countries especially.
So what comes next?
Most obviously, point (3) will persist. ECB supervision of Britain’s banking system is not seen as necessary, will not happen this November – uniquely, perhaps, in the EU – nor will it happen in the foreseeable future. British budgets will not be subject to Commission scrutiny. Indeed, compliance with the fiscal compact rules in that regard would require us to change our tax year to match the calendar year, as it does elsewhere: the financial equivalent of metrication and likely to be just as welcome.
More broadly, Britain’s position in the EU has never been quite as comfortable as it has been for other, equally proud sovereign nations such as Luxembourg. That level of comfort seems ever more unlikely to improve. This blog quoted one expert observer on the subject back in November 2011, after that month’s emergency summit but before the UK veto had been exercised:
A rival treaty organisation, predicated on common economic government, would become de facto the new forum for integration. One by one, political powers would pass from the EU to the eurozone until the EU became a shell, an amplified free trade area, a kind of EFTA-plus. Which, of course, would suit Britain very well indeed
Two and a half years ago, a two-speed EU looked like a dramatic idea. Today it is getting closer to being policy, on all sides. In another two and a half years’ time the UK could be on the brink of a decision as to whether or not to remain a member of the EU at all.
When it comes to the gathering European question of Brexit we should apply the same quality of analysis as we do to markets. Forget about the fluff – who said what on which tape, which faceless figurehead gets to be Chief Bureaucrat for the next six months, or what precise party postures are adopted to squeeze votes out of people that electoral cycle. The years we have just lived through represent exactly the sort of tectonic movement that causes major earthquakes. Whether we like it, or want to believe it, or not: these years have widened the English Channel, and undercurrents which were always there have grown more powerful.
It’s possible, if not a little hopeful, to see how Britain’s increasingly likely exit from the EU as the relationship now stands might benefit all involved. Of course it might also be a disaster. As a pair of alternatives that at least speaks to volatility. And over the medium term, we should be prepared.
This week saw Greece return to the bond market. The five year syndicated deal, out yesterday, was originally intended to raise €2.5bn at 5-5.25%. Such was the level of demand, however – reported at €20bn – that the eventual issue size was €3bn at a yield of 4.95%.
So much for the detail. Greece has returned to the bond market! A key milestone along the global path to recovery from the credit crunch has been reached. This is the first Greek government bond (as opposed to short-dated money market instrument) to be issued since March 2010. And the day before it was officially announced, the ten year Greek bond yield reached 5.89%, the lowest closing level since January 2010.
Greece has not figured much on the world’s radar this year but there have been a few other noteworthy firsts as well.
Two months ago, Prime Minister Samaras gave an interview in which he estimated the country would reach a primary budget surplus of €1.5bn for 2013, one year earlier than planned. European officials expressed some scepticism and cautioned that euphoria should be postponed until the figures are formally released on the 23rd of this month. The Eurostat / ECB data on the subject does suggest this would be a stretch, but it also shows that such a surplus (which ignores the cost of debt interest) would be the first to have been run by Greece since 2002.
Less uncertainly, there was another first announced at around the same time: 2013 saw the country’s first current account surplus since records began in 1948. This was partly due to falling imports – but tourist receipts were up 15% to reach a new record and exports rose too as lower wages led to greater competitiveness.
As ever it is imprudent to consider only the upside. Greek unemployment seems at last to have peaked, but remains at an eye-watering 26.7%. Serious civil unrest remains a threat; only yesterday a car bomb in Athens went off outside the central bank building (though no one was hurt). Politics is still an area of concern too, with an unpredictable radical left coalition leading polls and the nationalist far right coming in a consistent third.
Nevertheless: forecast data from the EU Commission produced in February shows recovery finally taking hold in Greece this year and strengthening into next. This is consistent both with the broader European outlook as it stands, and with the consensus – though the latter’s forecasts are more bearish in numbers terms. The road ahead is dangerous but the new bond issue is another step in the right direction. Eurydice is almost at the threshold of Hades; it is now more believable that she will not have to turn back after all.