22 August 2010

Greece: no news, good news? Not really...

After the Q2 2010 turmoil in debt markets across the euro-zone following Greek debt problem, everything went quiet from mid-July onwards: the euro dramatically jumped, CDS spreads shrunk and sovereign debt yields followed and media went quiet, like a remake of the Phoney war on the western front at the beginning of WWII.
We had however a few announcements and markets anticipations/reactions:
  • Slovakia did not participate in the first tranche of help to Greece and August 12 the parliament voted overwhelmingly (69-2) to reject taking part in a European Union aid package to Greece – wise men! The angry reaction from the European Commission tells a lot about its disrespect of democracy (this is one of the main roots of the flawed EU construction as we have witnessed it for the past 20-25 years – and don’t talk to me about the European parliament which is nothing more than a puppy House of Representatives). Whilst Slovakia participation in the rescue package (just over 1% of the European participation – EUR 80 billion) is meaningless, its parliament vote is meaningful: countries how small they are ready to stand and say enough is enough; democracy can regain control.
  • Without any surprise (who can think it would have been otherwise?!), on August 19 the European Commission said that Greece meets the conditions to receive the second part of the EUR 110 billion three-year emergency-loan package agreed on May 2: EUR 9 billion (including EUR 2.5 billion from the IMF); so we are at EUR 29 billion and counting (remember it was agreed that Euro-zone would lend EUR 30 billion during year 1 – we already are at 2/3)... This second tranche will be agreed by European Finance Ministers on September 7.
  • On the economic front, Greece’s GDP shrunk for the 7th quarter in a row at -1.5% during Q2 and inflation jumped to an annualized rate of 5.2%; I guess this inflation increase, way away from the rest of the euro-zone, is due to tax increases passed onto consumers. We are better Greece posting a nominal GDP growth in 2010 if such inflation continues on the same path, or one will have to very worried.
Let’s have a look at the 6 month progress report.
The numbers look rather encouraging with a 47.9% reduction in the ordinary budget for H1 yoy.
The revenue side remains however weak at +5.8% during the January-June period (42% of 2010 budgeted revenues), but we will have a clearer view of tax receipts in the next quarterly progress report, and in particular VAT and consumption taxes that represent over 2/3 of Greece’s revenues.
Most of the current reduction in the deficit comes from a decrease in expenditures (+/- 80% of the improvement). However, H1 expenditures already represent 55% of the full year budget.. A closer look at expenditures makes me more than circumspect regarding Greece chance to succeed. 60% of PIB have to be spent during H2 according to the most recently revised budget (and the EUR 9.2 billion has been reviewed downward in the tune of EUR 500 million compared to May) and interest rate payment will increase during H2 since the euro-zone loan bears a 5% rate and Greece has borrowed short term at rate much higher than last year, whilst it shows a decrease compared to 2009. You can see the squeeze: ahead for expenditures and late for revenues (Greece has a wild card: the EUR 3 billion EU help for infrastructure not yet paid that could arrive at the right time...).
Greece can squeeze even more expenditures but the key is on the revenue side and the bottom line is GDP growth. Without any growth, Greece will not be in a position to mend its public finances, and recent economic indicators are not encouraging; in addition, with inflation more than double the Euro-zone average and the GDP still shrinking, the economic divergence with the rest of Europe is increasing not the reverse. And do not forget, Greece is taking more debt every month, mostly financed by other Euro-zone countries and the IMF and its debt-to-GDP ratio follows the same path.
Greece is in a debt trap and I continue to believe that a debt rescheduling (not to call it a default), is the only solution to avoid a straight default or a breakup of the euro-zone. The German economy is doing well thanks to its exports. The economic (and social? political?) rift between Northern Europe and Southern Europe (France included) is widening. This is not sustainable.
What are markets telling us? 
After a relief (and an over-short market) following the publication of stress test for banks across Europe, the euro, sovereign debt yield and CDS spreads are again moving in the direction of anxiety.
Yield on Greek debt are again on the move…
… whilst at the same time yields on the German debt are reaching historic lows, therefore the spread between Greece and Germany is reaching historic highs and …
... the Euro is backing down after a 10% rally.
Finally, I had a look at the BIS quarterly bulletin and I noticed that French banks reduced their exposure to the Greek debt at the end of March, down to EUR 67 billion (-EUR 8 billion) whilst and German banks remained flat at EUR 44 billion compared to the end of 2009. I guess that this exposure has been further reduced since, the ECB becoming the investor of last resort.
In the meantime, the BIS is watering down new regulations to strengthen capital ratios for banks, putting emphasis on core capital; this will drag on, otherwise, the stress test that European banks passed so “successfully” would look meaningless (what it is anyway).
What about investments?
I have not changed for a couple of months: stay clear of Western banks (they are not all that bad, but there is better value elsewhere), invest in high growth economies (directly or via proxy companies), brand name consumer goods, and generally speaking companies with a franchise, a strong balance sheet and high yield on their shares (in this environment, income is key).
Financial Times: Slovakia under fire over Greece
Financial Times: Greece to receive further €9bn of bail-out
Hellenic Ministry of Finance: Budget execution – June 2010
Hellenic Ministry of Finance: The economic adjustment programme for Greece
Bank for International Settlements: Detailed tables on provisional locational and consolidated banking statistics at end-March 2010