Parliament's Budget Office Surprises!

When the head of Parliament's independent Budget Office states publicly that the social dividend planned by the SYRIZA government is counter-productive to much needed economic growth in the country, that should raise some eyebrows.

Several years ago, when it first became apparent that, some day in the foreseeable future, Greece might have a primary surplus again, I had made several suggestions as to what the primary surplus should be sued for ("Beware of the primary surplus!").

The first phase in a financial rescue is generally a phase where a borrower still needs fresh money in order to stay in business. Corrective measures have already been taken but it will still take a while until they show results. During this phase, the country still runs a primary deficit even though substantial reforms have already been made. That phase lasted in Greece until about 2013.

Phase II is where the deficit gradually turns into a surplus, initially rather small but growing steadily. However, doubts still remain whether that surplus can be sustained over time. What happens to the surplus during this time is of crucial importance.

Phase III is where everything is back to normal.

Greece now seems to be reaching the peak of phase II: from January-September 2017, the general government accounts registered a consolidated primary surplus of 5,3 BEUR, roughly the same as the year before and, according to the government, substantially above the target. It seems rather likely that, for the year as a whole, Greece's primary surplus will exceed 6 BEUR.

That is a sensitive number because Greece's creditors will undoubtedly remember that Greece's interest expense is currently running at about 5,5 BEUR annually (at current, subsidized interest rates). Put differently, Greece - for the first time since the crisis - could pay ALL of its interest out of the primary surplus this year. One would expect that creditors will put pressure on that.

However, Greece is still in phase II and the crucial question is how the primary surplus can best be applied in order to promote sustainable growth. Paying interest is certainly not conducive to promoting domestic growth. Will the social dividend be?

Without having any special insights into the subject matter, I would tend to agree with the Budget Office. A social dividend is generally for one-time consumption and that is it. The thought comes to mind that the Greek state owes substantial monies to domestic economic agents (unpaid bills, non-refunded taxes, etc.).

One would think that if the Greek state used a billion or two of its surplus to pay past-due bills with a special focus on small and medium sized businesses, that ought to have an extremely beneficial effect on the economy. That should also be in the interest of foreign creditors and domestic lenders because when small and medium sized businesses improve their performance, lending risks also decline.

One wonders why, with such huge monies flowing into Greece, why the state would have such high arrears in the first place. I seem to recall that parts of recent tranches were explicitly earmarked for the purpose of reducing arrears but the numbers don't show that this has happened.

The Incredible Shrinkage Of The Greek Banking Sector

The Greek banking sector has undergone massive changes since the crisis culminated with the First Memorandum in the spring of 2010. The tables below show how the aggregated assets, liabilities and equity of all Greek banks (excluding the Bank of Greece) developed between June 2015 and September 2017. It should be noted that these are aggregated (and not consolidated) figures, i. e. there may be significant overstatements of assets and liabilities. The equity should not be overstated. Source of the figures is the Bank of Greece.

AGGREGATED ASSETS
	Jun 2015	Sep 2017		Change
	(BEUR)	(BEUR)		(BEUR)
Loans to banks	116,4	15,0		-101,4	-87%
Loans to non-banks	281,0	195,4		-85,6	-30%
Debt securities	78,2	41,1		-37,1	-47%
Equities	18,7	8,6		-10,1	-54%
Remaining assets	50,4	55,6		5,2	10%
	--------	--------		--------	--------
Total assets	544,7	315,7		-229,0	-42%

Total assets declined by 42%! To say that total assets in the Greek banking sector were cut in half would be an exaggeration, but not by much! 229 BEUR of assets went away!

The largest decline was in interbank loans which declined by 101 BEUR. This is an understandable development: Greek banks had been active in the international interbank market (most of these interbank loans were to foreign banks) and as liquidity became tight, the Greek banks ran down that portfolio. Still, assuming that interbank lending was profitable for the Greek banks, the near-elimination of that portfolio must have impacted the banks' earnings potential.

The bulk of the loan portfolio of Greek banks represents loans to Greek non-banks (i. e. regular private and corporate customers). This segment accounted for 72 BEUR of the decline in loans. Loans can decline for one out of three reasons: (1) because they are repaid; (2) because they are sold off to investors; or (3) because they are charged off. I would be surprised if a very large portion of the decline in loans was due to repayments because loan repayments typically slow down in a crisis.

The only category which increased during this period was 'remaining assets' but the BoG does not provide any details about that.

AGGREGATED LIABILITIES & EQUITY
	Jun 2015	Sep 2017		Change
	(BEUR)	(BEUR)		(BEUR)
Debt to Bank of Greece	94,3	41,7		-52,6	-56%
Debt to other banks	75,8	18,9		-56,9	-75%
Deposits	294,9	156,7		-138,2	-47%
Securities issued	15,0	2,1		-12,9	-86%
Other liabilities	26,8	21,8		-5,0	-19%
Capital & Reserves	37,9	74,5		36,6	97%
	--------	--------		--------	--------
Total liabilities & equity	544,7	315,7		-229,0	-42%

The decline in the debt due to the Bank of Greece presumably represents the reduced dependance on ECB funding. A deposit decline of 138 BEUR, or -47%, speaks for itself. Of that decline, 94 BEUR were in the category of regular domestic deposits and another 19 BEUR were in the category of deposits from foreign countries.

As regards positive news, capital & reserves in the Greek banking sector almost doubled from 38 BEUR to 75 BEUR. When total assets shrink and equity increases, it has great beneficial impacts on the leverage in the system.

Venezuela As An Example?

Venezuela is now doing what Greece should have done in early 2010: meet with all its creditors to discuss a restructuring of the country's debt. On one hand, Venezuela is in a worse position than Greece was in then because Venezuela does not have the benefit of belonging to a common currency zone where the major players have to fear that Venezuela's default might bring the common currency down. On the other hand, Venezuela is in a better position: since the creditors know that there is no fall-back, they might be more interested in securing a deal.

The most critical, if not the holy principle of a sovereign debt restructuring is (or rather: was until the Greek restructuring) that 'risk takers must remain risk carriers'. If, say, Deutsche Bank had an exposure to Greece before the restructuring of, say, 100, it will end up with an exposure of 100 after the restructuring. Put differently, no creditor can reduce his risk exposure at the expense of someone else (ultimately at the expense of tax payers).

In fact, the principle of 'risk takers must remain risk carriers' should be quite acceptable to creditors. Normally when they go into a debt restructuring, they eventually come out of it with only 75 on 100, or even less. In case of an official bankruptcy proceeding, it's 20 on 100, at the most. So coming out of the sovereign debt rescheduling with 100 on a 100 is quite comfortable.

The only thing which should be required of existing creditors, once 'risk takers remain risk carriers', is that they are flexible as regards interest rates and maturities. This really is not asking much when compared to a private debt restructuring where creditors might lose much (or all) of their principal claims.

What is the incentive for creditors to go along with a debt restructuring like the above? It is the hope that, after the restructuring, their assets of 100 will be of better quality than their asset of 100 was before the restructuring. How can that be accomplished?

This is where official financial institutions (ECB, IMF) and governments become involved. Someone will have to negotiate with the debtor country sounder financial policies so that its debt becomes of better quality, and that can only be other governments and/or official institutions. Someone will have to coordinate the new terms and conditions with the existing creditors. Someone will have to come up with Fresh Money which the debt country normally requires to finance budget deficits and only other governments and/or official institutions can be expected to provide that. Finally, someone will have to exert open or hidden pressure on all creditors so that they 'play ball', and that can only be their governments and/or official financial institutions.

The Greek debt restructuring was not only a significant departure from rules governing sovereign debt crises until that time but is was also extremely unfair and inequitable to everyone involved except the original creditors. Tax payers bailed out private creditors and to an important degree, EZ tax payers bailed out the creditors of non-EZ countries. For example: China, the largest contributor to Greece's current account deficit in the 2000s, did not have to make any official contribution to Greece's restructuring and, presumably, there were also Chinese banks which profited from the bail-out. Not to mention UK and US banks which were pleased by-standers profiting from the Greek bail-out without having to share in its cost.

Life Ain't Fair To Unknown Passengers

This commentary from the Ekathimerini ("The unknown passenger's silent resistance" by Nikos Kostandaras) brilliantly captures a theme which I have tried to bring across on many occasions in this blog. The theme of a society where the clever operators built their economic well-being on the hard work and clean living of the 'unknown passengers'. The Greeks whom I met in Germany when I lived there during the 1970s were mostly guestworkers and akin to the 'unknown passengers'. When my wife talks about the Greeks in the small village where she had grown up, her family, their neighbors and friends, the villagers in general, she talks about Greeks akin to the 'unknown passengers'.

Those 'unknown passengers' rarely hit the headlines but one does come across them in day-to-day life. When foreigners rave about Greece and the Greeks, they do so with the 'unknown passengers' in mind; Greeks whom Kostandaras describes beautifully as follows:

"These are the people – and the children of the people – who in the golden age of our recent past were up at dawn, in long queues at bus stops, on their way to work when the nightclubs and bouzouki joints were still full of more privileged revelers. These are the people who would pay for permits to build a home or fix the family home in the village, while others would build illegally on public land; the people who made sacrifices in order to raise children, to pay their taxes and loans, to meet all their obligations. The country was built on their labor, while others set up their political and economic confidence tricks. With the workers’ acquiescence others cultivated the belief that anyone could do whatever they liked, with impunity."

"Life ain't fair" is an expression which one hears frequently in business life. Life certainly has not been fair to the 'unknown passengers'.