Yesterday, in a nationwide referendum, the Greek people voted by over 60% to turn down the terms of the most recent offer of restructuring by the so-called “Troika” – the European Union (EU) , the European Central Bank (ECB) and the International Monetary Fund (IMF). This has thrown the markets into a tizzy, but what does it really mean?
It’s been obvious since the first Greek crisis in 2010 that Greece would probably be unable to pay its debts. The debt to GDP ratio reached 160%, and repaying that quantity of debt would be hard enough if the economy was growing. But the tax increases and the deep spending and welfare cuts required by the Troika in return for some loan forgiveness and restructuring caused the Greek economy to plunge. Real GDP fell over 25%, the volume of industrial production over 30%, and unemployment soared. Forecasts of economic growth by the Eurocrats and the IMF have consistently been too high, and their forecast of the level of government debt and its ratio to GDP consistently too low. In the end, the Greeks lost faith. It seemed to them that they had endured swingeing austerity without any of the benefits that austerity was supposed to bring, and that the new proposals were more of the same. So the Greeks have walked away from the debt restructuring process and are now in default on their loans to the IMF. A €3.2 repayment to the ECB is due on 20th July, and it seems highly unlikely it will be paid. Because the ECB has refused any further emergency support for Greek banks, the country is running out of cash internally, and the Greek government has imposed capital controls.
A likely (but not inevitable) result of this crisis will be that Greece leaves the Euro-zone, the common currency used by 16 of the EU members, and reintroduces the drachma, which will devalue sharply against the euro. However, unlike the previous crises in 2010, 2011 and 2012, European institutions are much better prepared. There is a strong “bailout” fund (the European Stability Mechanism); banks have been recapitalised; the other European countries which shared the Greek problems in the previous crises have improved faster than Greece (though in Spain at least, there is a popular political party which would like to emulate Syriza’s tactics); and the ECB is now committed to intervening in bond markets to prevent damaging sell-offs, having learnt the hard way that a hands-off approach doesn’t work. In addition, the EU has made it clear that some support will still be given to Greece (for example, to buy food and medicines) and the IMF itself has published a report urging that Greece be given further aid and have its debts restructured. Since much of the debt is owed to the IMF itself, this is interesting.
Greece is just a quarter percent of world GDP, and just 1% of Europe’s GDP. The direct economic effect of any economic collapse on the world economy will therefore be limited. The effect on sentiment will remain, for now. Share markets dislike uncertainty and lack of clarity, and no one knows just what will happen over the next few days and weeks. Our view is that the contagion from this crisis will be limited, ultimately, and that both sides will compromise. Ironically, the drama in Greece has averted eyes from the bursting of the stock market boom in China, which longer term might be far more important for the world economy and financial markets. More on that in our next issue.
