With Greek Bailout 2 on its way, has the euro zone escaped the clutches of the markets? Not a chance. Greece remains the euro zone’s weakest link and Europe remains the sick man of the global economy. The reasons are simple: too much debt, not enough liquidity and too little growth.
Debt-wise, Greece is now actually worse off than when the whole mess of the second bailout began. After the private sector haircut, which, together with the European Central Bank swap, amounts to a $138-billion (U.S.) debt writedown, Greece is now in line for $170-billion in new loans, an additional $38-billion “pro-growth” lending facility from the IMF, and a standing $40-billion reserve loans facility for its banks.
As of today, the expected Greek bank bailout bill stands at $63-billion. Behind all that looms another $20-billion yet-to-be-announced lending package that will be required to get Greece over its 2012 targets, given the deterioration in its GDP. All in, Greek debt could rise by as much as $130-billion with Bailout 2, although the most likely number will be closer to $100-billion. This would bring Greece’s gross external debt from 192 per cent of GDP projected before Bailout 2 to more than 225 per cent, using IMF figures.
Keep in mind that Greece cannot print its way out of this debt, nor can it expect to grow its way out. The Greek economy is expected to shrink 3.2 per cent this year and post just 0.6 per cent nominal growth in 2013. Thereafter, rosy projections from the IMF are for 3.3 per cent average annual growth to 2016. All of this expansion is expected to come from gross fixed capital formation and exports. The former will be happening, according to the IMF numbers, amid shrinking public and private demand and zero private sector credit creation through 2014. The latter is expected to add 39 per cent to exports of goods and services over the next four years. German tourists better start coming to Greece in the millions, because feta cheese sales doubling between now and 2016 will not do the trick. In other words, the rates of growth envisaged by the IMF are purely imaginary.
On the liquidity front, the European periphery remains largely outside the funding markets. Even Italy is now borrowing in the markets courtesy of the ECB, through its pumping of cash into the country’s banks. Of the top 10 bank borrowers tapping the ECB’s long-term refinancing operations (LTRO) by volume, seven are from Spain and Italy. Fifteen out of the top 20 banks, measured as a ratio of LTRO borrowings to their assets, are from these countries. Since the beginning of 2009, the ECB has provided some $1.65-trillion of new funds. Much of this went into sovereign bonds and ECB deposits.
Now, here’s the obvious problem at the end of the supposedly cunning plan that the ECB contrived to shore up ailing banks. Euro-area banks are the largest holders of euro-area sovereign bonds. This is the main channel for contagion from the sovereign balance sheets to the banking system in the current crisis. LTROs 1 and 2 have just made that channel about a mile wider. Mopping up the expected tsunami of bonds that will hit private markets in and around 2014-15, when the LTROs wind up, will be a problem in its own right. Coupled with the bond redemption cliff faced by some peripheral countries around that time, it will assure that the problem will be insurmountable.
Constantin Gurdgiev is head of research with fund management firm St. Columbanus IA and lecturer in finance at Trinity College, Dublin.