Thursday, February 16, 2012

Greek government expenditures - Interest expense

With so much discussion about the state of Greece's public finances, it would be helpful to have a set of simple statistics which would allow the "normal" reader to understand what's going on. Instead, there are different sources of information (Greek Ministry of Finance, European Commission, IMF, etc.) which not only report in different formats but, oftentimes, work with different numbers. Above all, they simply love to work with "percentage-of" numbers.

In a restructuring, one has to start with numbers in absolute amounts because one can manage only absolute numbers and not percentages thereof. The "percentage-of" statistics are useful for subsequent analyses.

If, say, total expenses are 100 and one wants to reduce them, one needs to budget, say, 95 for the next period. Now it may well be that even though the expense reduction is achieved, "expenses as % of GDP" still increased. This happens when GDP declines even more than the expense reduction.

I have taken numbers from the following sources:

IMF Report #11; December 2011; page 55
European Commission Fifth Review; October 2011; page 101

Since the numbers differ quite a bit (perhaps due to the different publication dates), I will only use the IMF numbers.

Start with "primary expenditures". That is general government expenses without interest expense, the most important figure to control in any restructuring (because the interest expense can be negotiated with creditors). Primary government expenditures were 111,8 BN EUR in 2009. This is the number which will either be reduced or, as has been suggested, increased beyond control.

In 2010, primary government expenses were 101,3 BN EUR, or 9% less than in 2009. Expenses exploded out of control, as has been suggested? Well, a minus 9% is not really an expense explosion out of control.

In 2011, primary government expenses (latest projection) were 92,8 BN EUR, or 8% less than in 2010. Again, an expense explosion out of control cannot really be recognized.

One could go into expense details and state that wage expenses in 2011 were 19% lower (!) than in 2009, and in 2015 they are projected to be 33% lower (!!!) than in 2009.

Now to the interest expense. In 2009, they were 12,3 BN EUR and they increased by 2% to 12,6 BN EUR in 2010. Then, from 2010-11, they increased by 17% to 14,7 BN EUR. I have to admit: there is some expense explosion recognizable here.

And now is the time to move on to "percentage-of" figures. Interest expense as a percentage of primary government expenses increased from 11% in 2009 to 12% in 2010 to 16% in 2011.

The revenue side is a bit more complicated because there were substantial increases in taxes offset by a break-away in the tax base. Thus, revenues increased from 87,7 BN EUR in 2009 to 89,9 BN EUR in 2010 (+2%) but in 2011 they fell back to the level of 2009.

The "primary balance" is positive when revenues are equal or greater than primary expenditures. When the primary balance is positive, no new debt is required (unless there is interest to be paid). Greece is expected to have a positive primary balance in 2012. If tax revenues had not broken away as much as they did, Greece might have even achieved a positive primary balance in 2011.

So here it is. It all boils down to the interest expense. The mistake has been made to think that the interest expense can only be reduced by reducing the level of debt (i. e. haircut). A very, very unfortunate mistake, indeed!

Lower debt doesn't necessarily mean less interest expense: an increase in interest rates could compensate for the reduction in debt. There are 2 very effective ways to reduce the interest expense for a budget:

The standard way: just lower the actual interest rates charged.
The non-standard way: keep the interest rates where creditors want them to be but negotiate that only part of it is paid in cash (the rest capitalized).

Only the cash portion flows through the budget. On one hand, that is a benefit for the budget and on the other hand the creditors can still allow themselves to believe that, eventually, they will get the entire principal and interest paid (they won't, of course, but that is for the next generation of creditors to find out...).

What are some of the conclusions from the above?

1) Contrary to popular belief, the reduction in primary government expenditures has actually been quite substantial. To reduce primary government expenditures in absolute amounts by 17% within 2 years strikes me like it could be a world record.
2) If Greece could start from scratch again in 2012 (i. e. start without any debt), she would not need to borrow money to pay for government expenditures.
3) If only part of the time which has been spent on the subject of PSI would have been spent on negotiating more ceative ways to charge interest, everybody would be better off today.

1 comment:

  1. thanks - this is helpful. We certainly sense that our primary deficit should be very, very small, given what we're paid. Good to see the numbers.