5/31/12

The threat of a Greek exit: Unhappy in their own ways | The Economist

The threat of a Greek exit

Unhappy in their own ways
The escalating Greek crisis leaves Ireland and Portugal, in particular, ever more vulnerable
May 12th 2012 | from the print edition

THE deep

Mean streets getting meaner

uncertainty over what will happen next in Greece unnerved financial markets. On May 7th the euro touched its lowest value against the dollar since January while in Athens the stockmarket fell by 7% and bank stocks by 13%. Greek bonds also took a hit, with the yield on the ten-year bond rising to 22.9% (from 20.5% at the end of April). Investors piled into the havens of German government bonds and American Treasuries. The Dow Jones Euro Stoxx 50 fell to its lowest level so far in 2012. On the same day Angela Merkel, the German chancellor, was swift to insist that there could be no backtracking on the commitments Greece made at the time of its second bail-out earlier this year. By the end of
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Banks have more or less called a halt to new lending to Greek institutions. After an exit debts to foreign creditors would soar as the new drachma fell. That explains much of the €8 billion ($10 billion) in Greece-related losses that hit French banks last year. according to Credit Suisse—were to develop into an outright run. the second in 2014. Banks have found it difficult to cut lending any faster. from $86 billion to $69 billion. worth 5. leading to further defaults. the more corrosive its effects on confidence. Seeing this coming. the first in 2013.economist.5% of GDP.com/node/21554544/print 2/6 . On strict legal grounds. companies and banks. A departure might not be quite as catastrophic for banks elsewhere in Europe as once it would have been. But the panic would not be confined to Greece (which made up just 2. many banks had already written down the debt. these are to be carried out in two instalments. But that timetable now looks more or less impossible. Even if the European Central Bank (ECB) fought this with massive liquidity support. By the end of 2011 foreign banks’ exposure to the Greek public sector had fallen to about $23 billion from $64 billion in September 2010. Cross-border loans to Greek firms and households had also fallen. partly because www. which adds further to the risks. The bail-out deal agreed in February meant that private holders of Greek government bonds “voluntarily” had to exchange their holdings of bonds for new ones worth a fraction of the old. Relations between the country and its creditors may sour to such a point that a Greek exit from the euro—a “grexit”. according to analysts at Credit Suisse. Even before an exit Greece’s banks could collapse if the steady withdrawal of deposits—they are 30% below their peak. But the more real it comes to seem. Depositors in other vulnerable economies could take fright and try to withdraw their funds from their banking systems. This need not be a self-fulfilling prophecy.3% of the euro zone by GDP in 2011). even if a government can be found that wants to stick to the bail-out’s conditions. But that is still a lot. the crisis would shake already frail banks.5/31/12 The threat of a Greek exit: Unhappy in their own ways | The Economist June a Greek government is supposed to specify a further package of reforms and spending cuts. at risk of losing access to the single market.economist. Greece could find itself cast out of the European Union as well as the euro area. as it is coming to be known— becomes inevitable. especially in Spain (see article (http://www.com/node/21554545) ).

Bad. which have allowed banks to turn eligible collateral into cash on a grand scale. then. so they have sought other ways of reducing the potential losses that would follow if Greece adopts a new currency.com/node/21554544/print 3/6 . for Spain and Italy. With so much time to prepare for the worst.economist. Among the tools that they have been able to use are the ECB’s Longer Term Refinancing Operations. There are limits to this approach. which will insert public-debt brakes into national laws. But Greece is not the only place people are worried about. but the economic pain they are already undergoing is intense.” says the boss of one large European bank. An Irish rejection would not prevent the treaty coming into effect. many senior international bankers think that they may now be able to cope with the fallout of a Greek departure—which they see as highly likely.” Bond yields will jump in any country that might conceivably leave the euro once such an exit has actually happened. since deposits are scarce in Greece. Worse for Ireland and Portugal. then so too should be the money they have promised to repay. Last year elections in both countries produced reform-minded governments.5/31/12 The threat of a Greek exit: Unhappy in their own ways | The Economist some loans are not due to mature for years. which have already needed bail-outs. “It is still a taboo subject for open discussion with the regulator. A referendum on the German-inspired “fiscal compact”. and mean that they would not be bailed out in future. Banks are also trying to match loans to deposits in vulnerable countries such as Spain and Portugal. Their thinking is that if the money they are owed is worth less. with the rise proportional to the risk. but it would relieve the Irish of any obligations under it. is due in Ireland on May 31st and many Irish may be tempted to use the occasion to vent their discontent and add to the anti-austerity movement in Europe. The Irish and Portuguese governments are keen to distance themselves www. “But they know we have a plan C and are doing all the things you would expect us to be doing [to prepare]. One strategy is to gather Greek deposits to match the value of loans outstanding.

Ireland. The fiscal woes of the other two bailed-out countries are less intractable. Even after a default that more than halved the face value of private bondholdings (and reduced their net present value by three-quarters). are much lower than Greece’s (23. was not too bad. Portugal. has to do www. and Portugal’s.5% of GDP—a surplus that would need to be sustained all the way to 2020 just to bring its debt down to the levels at which Irish and Portuguese debt is expected to peak in 2013. even though it is paying low rates of interest on both its bail-out loans and its restructured private debt. Greece’s path is harder.5%) or Portugal’s (11.4%). That will be much higher than in Ireland and Portugal where.economist. the IMF expects Greece’s government debt still to be 161% of GDP in 2013 (see chart). though still high (at 7% on May 8th). for its part. Ireland’s ill-judged guarantee of bank debts in 2008 made matters much worse. debt is forecast to peak next year at 118% and 115% of GDP respectively. The awkward truth that European leaders failed to acknowledge in May 2010 is that the Greek state was broke when it received its first bail-out. That would give it a primary budget surplus of 4. They see the broad national consensus backing the programme as a crucial asset. Portugal is nearly half way towards reaching that objective. the Explore our interactive guide to Europe's troubled economies ECB and the IMF—for its determination to make policy reforms. often pointed to as a model pupil.com/node/21554544/print 4/6 . After an underlying retrenchment of about 4%. but it started off with a far better debt position.5/31/12 The threat of a Greek exit: Unhappy in their own ways | The Economist from Greece. The Irish can point to the fact that their benchmark bond yields. before interest payments) improved by 8% of GDP between 2009 and 2011. It has already made an extraordinary fiscal effort from a desperate starting-point: its primary budget balance (ie. has won plaudits from the “troika”—the European Commission. This distancing is reasonable: Greece’s fiscal and economic plight is undoubtedly the most extreme. But it still has to do almost as much again to make the further required gain of nearly 7% of GDP by 2014. though more worrying. assuming current plans are kept to. Debtsustainability analysis by the IMF suggests that they both need to aim for a primary surplus of around 3% of GDP. Yet both economies remain fragile. Domino dancing With its debt burden so great.

5/31/12 The threat of a Greek exit: Unhappy in their own ways | The Economist more because its primary deficit of 6. the economy picked up modestly last year. but owing to a better earlier performance that will make its cumulative decline since 2007 a less painful 6%. And thanks to a flexible labour market and an open economy it has already clawed back a good deal of the cost competitiveness it lost during the boom years. Greece’s was still higher. Whereas Ireland’s current account was just in surplus last year. Portugal will have a tougher year in 2012. announced plans to create 250 new jobs at its facilities in Dublin and Galway.5% last year.7% this year. a software firm. lured by a skilled workforce and a low corporatetax rate. After a grim slide between 2007 and 2010. earlier this month SAP. and is expected to grow this year—though by only a meagre 0. In particular it remains an attractive production base for high-tech international firms. especially in information-technology and pharmaceutical companies. buoyed by exports.3%. following a contraction of 1. That will be painful for the Irish. Portugal ran a deficit of 6. Ireland has some trump cards which the other two economies lack.4% of GDP. That will leave its GDP 9% lower than in 2007 (see chart). an astonishing level for the depths of recession. Greece has fared far worse.5%.7% of GDP last year was considerably higher than Greece’s and Portugal’s.7%. with output falling by 3. bringing its cumulative slump since 2007 to 17%. but they can draw consolation from a brighter outlook for recovery. with GDP collapsing by almost 7% last year and expected to fall by a further 4.com/node/21554544/print 5/6 . as their trading performance reveals. at 9. One reason is that exporters have been held back by an inability to get financing from www. By contrast domestic costs have adjusted much more sluggishly in Portugal and Greece.economist.

After frustratingly long delays some of the necessary changes have been made in Greece.economist. Privacy policy Cookies info Terms of use Accessibility Help www. is that Portugal looks the more vulnerable. Their ability to regain access to market financing in 2013 as planned (with Ireland dipping its toes into the water later this year) is far from sure. Even if a Greek solution can be found.5/31/12 The threat of a Greek exit: Unhappy in their own ways | The Economist banks which themselves have been facing a funding crisis. The European creditor nations led by Germany would do their utmost to safeguard Portugal and Ireland. since they confront vested interests in both countries that have kept labour markets inflexible (favouring people already in work against new entrants) and cosseted product markets. especially in Greece and Portugal. The market judgment. But that might not be enough. Greece is now caught in a vicious circle between political uncertainty and economic contraction. from the print edition | Briefing Copyright © The Economist Newspaper Limited 2012. Portugal has got off to a better start.com/node/21554544/print 6/6 . Within the single-currency area competitiveness has to be regained the hard way—by pushing down domestic costs or increasing productivity— rather than the easier-to-swallow medicine of devaluation. Although Portugal and Ireland might well have what it takes to stay in the system as it stands. the seismic shock of a Greek exit could ruin that. and perhaps making it less likely that they will elect a government that can manage to keep Greece in the euro area. not least to contain the aftershocks. expressed through bond yields. particularly where these are not exposed to foreign competition. exacerbating the economic misery that voters are rejecting. But Ireland’s debilitating banking crisis still holds it back. All rights reserved. although that progress now looks in jeopardy as the political drive wavers. Neither economy is in any state at all to weather a grexit. The renewed doubts over its commitment to meeting the conditions for its bail-out will impair investment and frighten households. but still has a lot of work to do. That is why “structural” reforms remain essential. Ireland and Portugal are still weak.

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