As Greece's political and economic conditions worsen, the conventional wisdom about Greece never abandoning the euro will be sorely tested
By Desmond Lachman
According to an old Wall Street adage, when the winds
are strong even turkeys fly. If ever there was a case to which this adage would
apply, it would be that of the market’s present favor for Greek government bonds.
Over the past year, as the market has stretched for yield in a low interest
rate global environment, the Greek government’s long-term borrowing cost has
declined from over 18 percent to its present level of 8.5 percent. And it has
done so despite increased signs that Greece lacks the political willingness to
resolve the many deep-seated problems that still characterize the Greek
economy.
Anesthetized by ample global liquidity, markets are
simply choosing to ignore many warning signals emanating out of Greece about
that country’s political and economic future. They certainly seem to be turning
a blind eye to the Greek government’s insistence that Greece has reached the
social and political limits as to how much more budget austerity and painful
structural economic reform the country can tolerate. They also seem to be
disregarding Greece’s stalled IMF-EU negotiations and increased signs that its
foot-dragging on real economic reform is causing Berlin’s patience to run out.
A troubling indication that Greece may now be on a
collision course with its official creditors was the Greek government’s recent
presentation of its 2014 budget without the blessing of either Brussels or the
International Monetary Fund. According to the IMF, Greece’s 2014 budget has an
unfinanced gap of around €1.5 billion. The IMF also notes that Greece’s efforts
at structural economic reform have fallen far short of the country’s
commitments under its IMF-EU program, especially in the areas of public sector
layoffs and privatization policy. This lack of progress would seem to make it
highly improbable that Greece’s official creditors would agree to yet more
bailout funds.
Markets also seem to be totally discounting the
possibility that the Greek government could fall next year and that the
far-left Syriza party, which is not known for supporting the IMF-EU policy
prescriptions, could be swept to power. They do so despite the deep divisions
that are now clearly apparent in the Samaras coalition government, which has
already seen its majority in Greece’s 300-member parliament whittled down to
only three members. They also do so despite the very real likelihood that the
Greek government will suffer a humiliating defeat in the May 2014 European
parliamentary elections that would make it difficult for it to continue
governing.
Equally surprising is the market’s apparent equanimity
about Greece’s dismal economic outlook, which seems to be driving its political
fragmentation. Despite the fact that Greece’s economy has contracted by almost
a quarter over the past six years and that Greece’s unemployment rate is around
28 percent, both the OECD and Moody’s are forecasting another small decline in
Greek GDP in 2014. They are doing so in recognition of the additional budget
tightening that Greece has to undertake to put its public finances on a sounder
footing as well as of the ongoing domestic credit crunch that is making it
difficult for households and companies to obtain much-needed bank financing.
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