Swedbank Analysis Post-election Greece: 10 questions and answers


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Cecilia Hermansson, Chief Economist at Swedbank, about Post-election Greece.

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Swedbank Analysis Post-election Greece: 10 questions and answers

  1. 1. Swedbank Analysis No. 6  18 June 2012 Post-election Greece: 10 questions and answers  Although New Democracy has won the Greek election by a slight majority, there is still considerable uncertainty how a government will be formed. New Democracy and Pasok together would have a majority, but it is unclear how the reform package will be implemented considering that these parties didnt previously take ownership of it.  Signals that the euro countries are willing to ease the reform package should be seen largely as a symbolic gesture to improve negotiations with the new government and strike a softer balance between austerity and growth. For the most part, the package remains unchanged, though the timetable to meet the terms could be expanded. It would be positive if the deadline to decide on 11 billion euros in cutbacks were delayed slightly.  Initially positive market reactions are a sign of relief that Syriza didn’t win the election, which would have increased the risk of a Greek default and exit from the euro cooperation. Given the uncertainty still swirling around the government, the fact that parliament is in no position to decide on cutbacks and that a payment default still can’t be ruled out, market concerns are likely to increase once again. There is also a risk that the government won’t last and a new election will have to be called after the summer. Even if Greece manages to reverse its slide, it will take years to turn the economy around. Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46 (0)8-5859 7740e-mail: ek.sekr@swedbank.com Internet: www.swedbank.com Responsible publisher: Cecilia Hermansson +46 (0)8-5859 7720. Magnus Alvesson +46 (0)8-5859 3341, Jörgen Kennemar +46 (0)8-5859 7730 ISSN 1103-4897
  2. 2. Question 1: What do the election resultsshow?New Democracy has won the Greek election by a slight margin. New Democracy hasWith practically all the votes counted (99.86%), it took 129 seats won, but what thein parliament, with the leftist coalition Syriza winning 71 and government will lookPasok 33. Syriza’s leader, Alexis Tsipras, has congratulated his like is unclearNew Democracy counterpart, Antonis Samaras, on the victory.In all likelihood, Samaras will be named the new prime ministerof a coalition government, though there is still considerableuncertainty how a government will be formed.According to Greek law, the party that wins the most votesreceives an additional 50 seats in parliament, so the differencebetween New Democracy and Syriza was actually muchsmaller, 29.7% vs. 26.9%, or 79 seats vs. 71 seats without theextra 50. Pasok received 12.3% of the votes, down from theMay election. The extreme right Golden Dawn party receivedabout the same share of votes as the May 6 election, 6.9%, and18 seats. This gives it a place in parliament and underscores awidespread displeasure with the established parties.The young – many urban and without work – voted more for theleftist alternative, Syriza, while more older and wealthier voterschose the New Democracy center-right alternative. Its worthnoting that a majority of the population didn’t vote for either ofthe two parties that are expected to form a government.Question 2: What do the results mean forGreece?It is unclear how the government will turn out. New Democracy New Democracy anddidn’t receive a majority and has to form a coalition. Pasok Pasok may eventuallyannounced early on that unless Syriza was part of the govern, but haven’tgovernment it wouldn’t join, but Syriza prefers to be in previously takenopposition (with the possibility of gaining greater support if the responsibility for thenew government fails). reform processIf New Democracy manages to persuade Pasok, the traditionalparties will have a majority and regain power (162 of 300 seatsin parliament). These two parties have signed the loanagreement with the so-called troika (the IMF, EU Commissionand European Central Bank, ECB). While they intend to fight forless onerous terms, there has been no mention of tearing upthe entire package as with Syriza. This increases the likelihoodthat Greece will accept austerity and remain in the euro zone.Pasok and New Democracy havent previously shown awillingness to comply with the reform package. Many of theterms haven’t been met and the measures have been delayed.This includes liberalizing the guild system and product markets,privatizing state enterprises and improving tax collection.Although the major decline in the Greek stock exchangecomplicates privatizations, a slightly faster pace of governmentsell-offs is possible.2 Swedbank Analysis No. 6 • 18 June 2012
  3. 3. The question is how the new government will reform the countryand whether it will be able to stay in power for any length oftime considering the many challenges and the differing opinionsbetween New Democracy (with a right-leaning ideology) andPasok (more leftist) about what has to be done.Even if a new government is formed, there are still severalchallenges before it is certain whether a euro zone exit can beavoided. A decision first has to be made about 11 billion euro inausterity before the euro zone will release its next payment. Ifthis doesnt happen, there is a risk Greece will default on itspayments on July 20, when it says it will run out of money. Untilthen bank withdrawals will continue, which could eventuallyresult in an exit from the currency union if it isnt stopped.Question 3: What would have happened ifSyriza had formed a government?If Syriza had won the election, received the extra 50 seats and Syriza promised votersfound willing coalition partners to form a government, the they could keep thesituation would have been quite different. Those who voted for euro – but withoutSyriza wanted to see politicians who hadnt previously been meeting the terms ofresponsible for the country’s mismanagement and neglect. the reform packageThey had also hoped that the country could keep the euro, butwithout taking the measures associated with budget disciplineand improved competitiveness. Syriza campaigned on keepingthe euro, the emergency loans and the write-offs, but wants totear up the austerity package, which they feel is unrealistic.Instead Syriza would have introduced a national reconstructionprogram based on its left-leaning policies.Had the austerity program been torn up as Syriza promised,lenders would have probably frozen the emergency loans andGreece would default on its payments – first in the form ofdomestic payments for salaries and pensions and then toforeign lenders. Syriza had planned to use the interestpayments on the foreign loans to invest in growth.With even more bank withdrawals, capital flight and bank panic,Greece would have had to transition back to its old currency,the drachma, which would probably be valued at 40-50% of theeuro. This would help exports but make imports that much moreexpensive. The Greek central bank would have had to print a lotof money to capitalize the nationalized banks and finance thegovernment budget, which isn’t yet generating a primarysurplus, i.e., excluding interest payments. With higher importprices and overheated printing presses, inflation would haverisen to double digits and interest rates would haveskyrocketed.Syriza, which had promised not to trim the state apparatus, hasat the same time announced that it would raise tax revenues.The question is whether it would have succeeded in markedlychanging taxpayer behavior in the short term. It is more likelythat little would have come of the party’s election promises.Swedbank Analysis No. 6 • 18 June 2012 3
  4. 4. Turbulence in the financial markets, capital flight andsignificantly lower asset values would have also led to corporatebankruptcies, higher unemployment and the risk of politicalinstability.Because the new currency would have cut the wealth of Greekcitizens (and GDP) in half after a euro exit, at the same timethat foreign debt in euro wouldnt have changed in value, apayment default would have been necessary and led toincreased isolation from investors, lenders and even the EU andIMF. There would have also been a risk that Greece would havehad to leave the EU.Geopolitically, Greece’s new friends would have probablyincluded Russia, China and Venezuela. Tension with Turkeystill exists, and huge cuts in the military budget (from very highlevels) would have increased in the dependence on alliancepartners outside NATO.Question 4: If the parties don’t manage toform a government, what will happen?The parties have already declared that it is crucial a A new election aftergovernment is formed fairly quickly, so there is probably room the summer cant befor compromise. ruled outThere is still a possibility, however, that the parties will fail toform a government. For example, there is a risk that Pasok willnot want to govern with New Democracy, since it could be hurtby supporting policies that go against its core beliefs. Syriza hasalready taken over many of Pasok’s supporters. That makes anew election a possibility. Until then a caretaker governmentcould be formed, which would delay any difficult decisions andincrease uncertainty and turbulence in the financial markets.A new election is also a possibility if a new government fails tolast, one of the parties drops out and a majority is no longer inplace to execute the policy. There are fears this could happenas soon as after the summer.Question 5: How likely is it that lenders willaccept renegotiated terms?Even before the election results were finalized, Germany’s It is reasonable toForeign Minister, Guido Westerwelle, suggested that the expect that lenders willausterity could be eased. It is likely, however, that the troika and ease some of theirthe euro countries would have handled a Syriza-led government termsdifferently. If Syriza had won, it would have been harder to seethe troika meet the new government halfway due to Syriza’spopulist rhetoric and the policies it wants to implement,including nationalizing formerly public institutions andmaintaining the relatively large public sector – contrary to thebailout package.4 Swedbank Analysis No. 6 • 18 June 2012
  5. 5. On the other hand, if New Democracy succeeds in forming agovernment with Pasok, there is the possibility that the troikaand the heads of the euro zone will agree to ease theirdemands. This could include extending the deadline for meetingthe terms (a delay in deciding on 11 billion euros in spendingcuts would be welcome), as well as investments that facilitate atransition to economic growth.It is also important that Germany shows empathy for thedifficulties faced by the Greek people now that unemploymenthas risen to over 22% and where measures are needed toassist the many young unemployed in particular. The troika andeuro countries also have to convince the financial markets thatausterity is realistic. Otherwise concerns will continue to spreadto other crisis countries.Question 6: What do the election resultsmean for the euro zone?The election results increase the likelihood that Greece will The euro countries areabide by the terms of the bailout package and not exit the euro likely to ease termszone. This is provided that the new government supports the somewhat, but there ispackage and we dont see a government crisis in the near term. still a risk of a GreekIt is also important that the wave of recent withdrawals in the exitbanking sector can be stopped. The ECB has to support theGreek central bank and facilitate a capitalization, so that thebank panic doesnt worsen and spread to other crisis countries.To receive the next payment, parliament has to find 11 billioneuros in spending cuts, which could prove difficult and createconcerns about a default despite the formation of a newgovernment. Moreover, it is unclear how the new governmentwill follow the program, i.e., how quickly reforms can beimplemented and in what way. Without a willingness to reform,there is a risk that the package will fall apart and spark reneweduncertainty about Greece’s place in the currency union.We cannot rule out, therefore, that Greece’s fate will remainuncertain despite the outcome of the election. In a Greek exit,the euro zone’s taxpayers would lose over 100 billion euros thatthe Greek central bank owes the other central banks throughthe Target2 system. Without an exit, it’s more of an accountingquestion how the funds will be adjusted between euro countrieswithin the central banking system, but if Greece is no longerpart of this system the other euro countries (mainly Germany,which is responsible for about a third) will have to pay the cost.Lenders will also lose money if Greece exits the currency union.The ECB has purchased Greek bonds valued at 56 billion euro.The euro countries have lent Greece 161 billion euros and theIMF 22 billion. European banks have receivables from Greecethrough government bonds they purchased for 55 billion (afterwrite-offs). International banks still have receivables from Greekbusinesses and households worth 69 billion, of which Frenchbanks (37 billion) are most at risk, while British (8 billion) andSwedbank Analysis No. 6 • 18 June 2012 5
  6. 6. German banks (6 billion) are slightly less exposed. This doesntinclude the insurance companies and pension funds that havepurchased Greek corporate bonds.Another important factor if Greece exits the euro zone iswhether the contagion will spread. The first to be affected wouldprobably be Cyprus, which has awaited the election resultsbefore formally requesting emergency loans from the EU, ECBand IMF. It’s possible that the country will need emergencyloans of up to 50% of GDP to capitalize its banks, or about 9billion euros. Foreign banks have an exposure of 36 billioneuros.There would also be expectations that Portugal and Irelandwould have to give up the euro, creating further turbulence andraising risk premiums and financing costs for these twocountries. Even worse is the possibility that this would thenspread to larger countries such as Spain, which already facesproblems in its banking sector, and Italy, whose high debt andweak competitiveness are worrying markets. Withdrawals fromGreek banks are a problem, but would be even more so if thecontagion spreads to Spanish and Italian banks.It is equally important how a Greek exit would affect the eurocollaboration in general. A country cannot officially leave thecurrency union, but if one or more did so nonetheless,confidence in the currency would wane. To date the euro haslost fairly little against other currencies, although its slide hasaccelerated of late. If Greece exits, confidence in the eurowould be affected. On the one hand, the currency union wouldbe hurt by its increased fragility. On the other, it could be helpedby having a weak member drop out and the stronger onesremain.Integration in the euro zone would probably be affected as well.The crisis has accelerated changes in its institutions, and thepace of reform could slow if instability is reduced. If morecountries exit the euro zone, however, there is a risk that theEU will also be affected, which could mean less integration in anumber of areas.Question 7: What kind of market reactioncan we expect?The outcome of the Greek collection on June 17 should please The equity andthe financial markets. Asian stock markets have risen and the currency markets haveeuro has strengthened slightly. The results have to be seen as initially reacteda relief, since the party that wanted to tear up the austerity positively, but their joyprogram didnt win. The risk of an exit from the currency union could be short livedhas temporarily declined, and the new government will providea counterparty for the troika to negotiate with. The pace ofreform should increase compared with the caretakergovernment and former technocratic government that led thecountry in recent months.6 Swedbank Analysis No. 6 • 18 June 2012
  7. 7. The focus of the financial markets has already shifted to Spainand Italy and eventually will turn to France. The serioussituation facing Spanish banks is also affecting French banks,and by extension the budgets of both countries. The financialmarket is carefully monitoring what the euro zone is doing tostrengthen its institutions and to form a banking union with asingle regulator, a deposit guarantee and resolution practices.Another priority is how support can be transferred directly fromthe structural funds to the banks without raising national debts,as happened in Ireland and now most recently Spain.Question 8: How serious is the situation inthe Greek economy?The situation in the Greek economy is grave. The onslaught of Greece is not inwithdrawals from banks shows a lack of confidence that a euro recession – its more ofexit will be prevented. Hospitals and energy companies cannot a depressionpay their bills, and without new emergency loans the state willdefault by the end of next month. Greece is in its fifth year ofrecession. Between 2007 and 2011 the economy shrunk by justover 13%, and an additional loss of 5-6% is expected this year.It would seem that Greece is actually experiencing a depressionconsidering its lost production, high unemployment andcollapse of its economic system.Greece’s GDP growth (%)Unemployment exceeds 22% for the population as a whole, butis around 50% for young adults. One in five people work intourism, which is being hurt by uncertainty. The election resultscould all generate more last-minute travelers if a governmentcan be formed and stability is achieved.Swedbank Analysis No. 6 • 18 June 2012 7
  8. 8. Unemployment in several euro countries, % of workforceThe Greek economy has been weak for several years.Competitiveness is clearly trending lower with rising unit laborcosts due to low productivity growth and rapidly rising laborcosts.Unit labor costs in manufacturing, index 2000 = 100 180,00 170,00 160,00 150,00 DE 140,00 ES 130,00 FR 120,00 EL IE 110,00 IT 100,00 90,00 80,00 1996 1998 2000 2002 2004 2006 2008 2010The low interest rates in connection with the nominalconvergence of the money and bond markets drove real estateprices higher, which in turn raised consumer prices and reducedreal interest rates. Imports grew substantially, while exportsdeveloped more modestly. The result was a large currentaccount deficit, which is now being reduced by the slowdown inthe economy and collapse in imports. The key, however, is toimplement reforms that raise competitiveness, not only bycutting wages and pensions but by improving productivity.8 Swedbank Analysis No. 6 • 18 June 2012
  9. 9. Current account balance in several EU countries, % of GDPPercentQuestion 9: What does Greece have to doto turn around?It is important that the new government implements reforms that Greece has toimprove competitiveness in the economy as a whole and implement extensivebudget discipline in the state apparatus. According to question structural reforms – a8, competitiveness has declined throughout the 2000’s, while necessity with anyGreece was unable to devalue and costs rose faster than in currency systemcompeting countries. Budget discipline was worse than firstreported when Greece entered the euro zone, which meansthat the budget deficit was larger and government debt hadincreased more. The key now is to balance revenue andspending, which means a downsizing of the public sector aswell as better tax collection and taxpayer ethics.Competition in product markets is being held in check by theguilds that protect various professional groups. Liberalizationwould benefit consumers and stimulate growth. State-ownedenterprises have to be privatized in order to increaseproductivity and efficiency. To date the pace of reform has beenslow, but it is critical that the austerity package agreed to isfollowed at the same time that weak groups are betterprotected.Greece’s politicians havent supported the reform package yet,which creates a risk that it will fail. The new government has totake responsibility and ownership for the economy. This will beSwedbank Analysis No. 6 • 18 June 2012 9
  10. 10. the most important element in the negotiations between thetroika and the government, which means that the troika has toagree to concessions and the government has to take over theprogram. It is uncertain whether this will happen consideringthat the parties – the same ones that signed the agreement –haven’t taken responsibility so far.Question 10: What do developments inGreece mean for the Nordic and Balticregions?Only Finland and Estonia, as euro members, are affected by the The Nordic andnegotiations with the Greek government on terms and loan Baltic countries areprograms. Although it is unlikely that more money will be given mainly being affectedto Greece, an extended deadline to meet the terms could make through export andthe program more expensive. investment marketsIf a government is successfully formed and an exit from thecurrency union is avoided, the election results could mean aslight improvement in the euro zone’s situation thanks toincreased stability. This would benefit exports and investment inthe Nordic and Baltic region as well. Less uncertainty wouldalso help the economy by encouraging households andbusinesses to spend and invest.Many questions still remain, however, and concerns aboutSpain and Italy have grown. Greece has taken a small step inthe right direction, but there is still a risk that it may default onits payments and exit the euro zone – a risk that continues tocreate concerns about the euro zone, but also for Europe,including the Nordic and Baltic regions. It will take many yearsto strengthen the institutions in the euro zone, improveconditions in the crisis countries and create stability and growth.Until then northern Europe will see its key export markets growbelow their potential. Creating increased political stability isimperative if the countries are also going to tackle theireconomic challenges. Cecilia Hermansson10 Swedbank Analysis No. 6 • 18 June 2012
  11. 11. Economic Research Department Sweden Cecilia Hermansson +46 8 5859 7720 cecilia.hermansson@swedbank.se Group Chief Economist Chief Economist, Sweden Magnus Alvesson +46 8 5859 3341 magnus.alvesson@swedbank.se Head of Economic Forecasting Jörgen Kennemar +46 8 5859 7730 jorgen.kennemar@swedbank.se Senior Economist Anna Ibegbulem +46 8 5859 7740 anna.ibegbulem@swedbank.se Assistant Estonia Annika Paabut +372 888 5440 annika.paabut@swedbank.ee Chief Economist, Estonia Elina Allikalt +372 888 1989 elina.allikalt@swedbank.ee Senior Economist Latvia Mārtiņš Kazāks +371 67 445 859 martins.kazaks@swedbank.lv Deputy Group Chief Economist Chief Economist, Latvia Dainis Stikuts +371 67 445 844 dainis.stikuts@swedbank.lv Senior Economist Lija Strašuna +371 67 445 875 lija.strasuna@swedbank.lv Senior Economist Lithuania Nerijus Mačiulis +370 5 258 2237 nerijus.maciulis@swedbank.lt Chief Economist, Lithuania Lina Vrubliauskienė +370 5 258 2275 lina.vrubliauskiene@swedbank.lt Senior Economist Vaiva Šečkutė +370 5 258 2156 vaiva.seckute@swedbank.lt Senior EconomistEconomic ResearchDepartment Swedbank Analysis is published as a service to our customers. We believe that we have used reliable sources and methods in the preparation of theSE-105 34 Stockholm analyses reported in this publication. However, we cannot guarantee theTelephone +46-(0)8-5859 7740 accuracy or completeness of the report and cannot be held responsible forek.sekr@swedbank.sewww.swedbank.se any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well.Legally responsible publisher Neither Swedbank nor its employees may be held responsible for losses orCecilia Hermansson, damages, direct or indirect, owing to any errors or omissions in Swedbank+46-8-5859 7720. Analysis.ISSN 1103-4897 Swedbank Analysis No. 6 • 18 June 2012 11