The IMF or EMF??

We rise in glory as we sink in pride. This is what I have to say to the EU leaders and ECB officials, as they quickly dismiss any talks of an IMF rescue for Greece. The IMF seems to me the best way out for Greece with all its fiscal mess and politics involved in the matter. Let’s face it, that today no eurozone country is audacious or willing enough to get into this ‘delicate’ issue of sovereign default and debt assurance, specially after grinding through such terrible economic times. What Greece is looking right now is for some generous donor to grant an easy loan with low interest rates and in return it will promise to cut down its fiscal deficit by adopting real disciplinary measures.

Here are a few reasons in a nutshell as to why I feel Greece’s bailout is a ‘delicate’ issue:

ü      Any loan or bailout money provided to Greece would be along with a number of constraints attached to it. Nobody would be willing to give a ‘no-frills’ loan to Greece considering its past record of conceited accounting practices and inexperienced policy makers. It is obvious common sense that any entity would like to protect its investment and make sure it oversees its utilisation.

ü      Secondly, there is an inevitable political angle as well which needs to be looked into. There already massive protests across Greece by its unhappy citizens over the government’s resolute commitment to cut public spending and public sector pay freezes. Already unions have endured enough, and one feels that the tipping point is not far away. Thus, in such a heated political environment, having foreign country or interests dictate control and supervision over its policymaking will further add to the fire.

ü      Thirdly, all hopes of the Euro’s future are hinged on a quick, transparent and stable Greek recovery, as the fear of contagion spreading to Portugal, Italy and Spain is high. As a consequence, any hiccups in the bailout may cause sharp reactions from bond markets. Which leads to my argument that what is required is a patient and calibrated approach, but not many would be looking at long term scenario, except the IMF.

Who will take out the chequebook?

Setting aside the IMF as one major contender for this job, let us examine who are the possible contenders. First on the list is the EU, which cannot explicitly bail Greece out as per the treaty clause which governs its functioning. Second, would be unilateral loans form the rich and prosperous European states, which in its current circumstances narrow down to Germany. Germany is the real powerhouse of Europe, also being one of the main beneficiaries of the introduction of Euro currency. Thus, more than an obligation, the last thing Germans want is a euro collapse in a fragile recovery period of today.

But, the German public is outraged by the idea of bailing out the profligate Greeks with their hard earned savings. To me a German bailout looks less probable than a German supervision. This leaves us with only 2 remaining choices. One is a real institution with more than 60 years experience of handling such cases, none other than the IMF. The other is EMF, which is fictitious and is a yet to be started fund. And so one feels the idea of EMF is promoted purely on pride and less logic.

It drives me nuts to read how EU policy makers are so blindly hopeful on setting up the European Monetary Fund as it is currently named. The IMF is clearly a better alternative even though the setting up of EMF is great for future crises but not the present Greece concern at hand. In simple terms, on having met with an accident does a person go to a experienced and reputed hospital, or does one choose go to a new, inexperienced and a politically correct clinic. Of course one chooses the former over the later. Then why make a distinction here for Greece.

Greece certainly needs help, and IMF for me looks like the safest bet. Disillusioned European leaders and policymakers need to shun their pride and also look at another positive from it. An IMF rescue will set a good example for the rest of the eurozone nations. An EMF rescue even if possible will imply a ‘too big-to fail’ guarantee, which will make future defaults even more dangerous.

Greece faces a tough year ahead

For those of you who have just joined us and asking what in the world is happening. Here’s the situation: We’ve got in our hands the possibility of the first sovereign debt default by a Euro currency member. Greece has an external debt of 170% of its GDP and is currently running a 13% fiscal deficit. The nation’s problems are increasing day by day. Productivity and employment are at very low and painful levels, for the country to even think of self sufficient recovery.

Much of the panic subsided on Feb 3^rd, as the government’s plan to reduce substantially it’s budget deficit to 3% by 2012, was supported by the EU. The plan proposes up taking very unpopular measures to control spending, like slashing public sector spending, pay freezes and wage cuts and increasing taxes. This hasn’t gone down well with public at all. They have already absorbed the 4% pay cut and are expecting the worst is yet to come. However, fear is again creeping into the minds of investors.

There is no doubt that this year's plan to cut deficit from 12.9% to 8.7% will be very difficult and regaining confidence even more.

The bond markets are increasingly skeptical about the government’s plan as the spreads on Greek bonds are rising. What Greece needs foremost is quick cash to refinance it debt which becomes due in a few months. The debt is estimated to the tune of €20 billion. It has been successful to raise €8 billion on Jan 25^th through the sale of 5 year bonds. However the rate of interest was very high at 6.2%. With more speculation on Greece’s future going rounds, picking up further debt from markets will become next to impossible for the government at prevailing interest rates.

The government has tried to blame the speculators who have bought credit default swaps (CDS) to insure themselves against a Greek refusal to oblige on the debt. They have alleged that buyers of CDSs are driving up the spreads on bonds and have made borrowing more difficult. That in turn has made the Greek government helpless and led to its current state of affairs. While there have been some officials and economists in Europe who have sympathised on these grounds. But I have two words for them.

Shut up!

The Greeks have no one to blame than themselves. Markets don't show sympathy, they respect discipline and trust. Years of profligacy and dodgy accounting practices in an  attempt to fool the EU and the investors, has left them in a terrible position. There is increasing furore in France and Germany on why it should bail out a cheater. Their displeasure is completely understandable and rightly so.

Its time Greece did the right thing and took some excruciating steps to control the budget and announce some real cuts and meaningful trust-building measures. Passing the buck around, will neither impress the EU nor the investors holding Greek bonds. Its time it pressed the button of urgency and did things swiftly and not smirk around looking for easy deals with the EU or the big members. The more it waits. The more the threat grows, specially for the other European economies, which also have high debts to service, namely Portugal, Spain and Italy. Its time it pleaded guilty. 

Do or Di(v)e for Euro

The response to the trillion dollar support package announced by EU for Greece has mostly been negative. The investors feel that it is still not enough to save the sinking European pride. The pride and unwavering faith in the euro was mistaken to be the absolute truth. With pacts and regulatory bodies in place, the Europeans thought their model was unique in economics and finance; just as their political clout was.

The Eurozone countries' average fiscal deficit as a percentage of GDP is a around 7 % which is well over the limit of 3% as per the above pact.

However, today for most, including me, the Euro has failed in this present set up and so has the European Union. It is quite shocking to see that none of the Eurozone countries are within the fiscal deficit limit set by the Growth and Stability Pact. Their average fiscal deficit as a percentage of GDP is a around 7 % which is well over the limit of 3% as per the above pact.

The reason for this as mentioned by me before (http://finmadeasy.blogspot.com/2010/02/euro-has-its-inherent-risks.html) rests in the clash between the two roles played by Euro member nations. Firstly, all members maintain sovereignty in their political, economic and foreign affairs which in many ways lead to many voices and adversely makes Europe sound like one noisy and divided entity. The EU in simple terms was designed to make their voices coherent as one and a collective European opinion which the world would respect. Sadly, today the collective consensus reached in Brussels is not respected by fellow member states themselves. So what we have seen till date is that member states have put national issues before their European obligations.

Their second role is to work together as a united region and uphold the European legacy, to command respect in a multi-polar world of today. Often egos are bruised, like Angela Merkel’s in the run-up to the stimulus decision, and often issues are dealt with a strong hand in unison. But rest (or most) of the times, members go around trying to show their might, trying to not let the EU take the stage lights off them.

Held at ransom

The message markets have sent is clear. The market is no longer going to be fooled by smart talking and insubstantial measures. They want to see the real deal. Some legally bound promises and structural changes to the Euro system are essential to placate market sentiments. After the Greek catastrophe, Euro bonds are already on a thin line.

Eurozone member states need to come up with concrete plans to limit their fiscal negligence and until then no sums of money promised will be adequate enough to win back confidence. They have to act fast or otherwise, a second dip is not far away.

The Euro Has Its Inherent Risks

The whole drama surrounding Greece and its high chances of default today is quite exciting and necessary. Just at the time, when economists were martyring the US dollar, it has put the euro back into the spotlight. In my earlier post in August on the global currency debate, I had mentioned that it was too early to write off the dollar against the euro, which hasn’t been tested till date. Thus, I say exciting. And necessary because it leads us to understanding the Euro and the innate risks it was born with.

I feel that there is very little we can do to prevent another Greece from happening in the next decade. The euro is the official currency of 16 nations out of the 27 member nations of the EU. Thus the money supply and banking sector is regulated under the common European Central Bank headquartered in Frankfurt, Germany. The euro currency arrangement is somewhat fundamentally similar to the US Federal bank model, where a number of prosperous states, each having the economic capacity to exist as a nation are governed under single monetary regime.

But when we talk of the euro, economists have failed to take into the account the impact of foreign and domestic policies of the sovereign member states. 

The EU as a body has on very few occasions had collective consensus on important foreign affairs and trade related matters. Then how can we expect them to agree on issues as basic as financial regulation, asset bubbles and labour laws.

Simply put, a euro member nation is still functioning as a sovereign state fighting for the same resources and markets as its co-member nations. These guiltless vested interests appear in the form of different growth patterns and asset bubbles in different sectors for different countries. For instance, in Spain and Ireland we saw the housing bubble, which was justifiable before the crisis, as it created jobs and pushed up their economies. But post crisis has put strains on the Eurozone.

The main objective of the ECB under the treaty is to maintain price stability. It keeps with itself target of 2-4% inflation in the Eurozone. But here again comes the problem. Not everybody can be given the same medicine. For instance, Italy, Greece, Spain and others immediately after the crisis had to contend with high unemployment rates upto 10% and sizable drop in exports. If not of the euro, they would have revalued their respective currencies to support export and labour incomes. But instead, they had to grind through a period of deflation and even higher unemployment. On the other hand, France and Germany were first to come out of the recession.

The buck stops here

Hence, I come again to my main point that economists and policy makers have underestimated the impact of political and historical differences within the Euro currency arrangement members.

Firstly they have to stop passing the bill for a Greek bailout. The more indecisive they are, the more Greece suffers. Secondly, there has to be better coordination and transparency among the members. Let us see how the story progresses.