10/01/2012 06:07 PM

Troubled Troika

Europe Intent on Saving Greece Despite Lag in Reforms

By Julia Amalia Heyer in Athens


Greece's creditors have been less than impressed with the country's willingness and ability to carry out much needed reforms. But Europe is likely to continue supporting the country anyway -- out of fear of the consequences should the country go bankrupt.

They're at odds, once again. The recent standoff in Athens between Poul Thomsen, chief envoy of the International Monetary Fund (IMF), and Greek Finance Minister Yannis Stournaras was, by all accounts, rather heated. Stournaras even threatened to resign rather than implement the cuts Thomsen was calling for, reported the New York Times.

"It doesn't matter to me," the IMF envoy allegedly replied, and then left.

On Friday, Sept. 21, it was time for the "Men in Black," as the Greeks call them, to depart once again -- without having accomplished anything. The troika, consisting of representatives of the IMF, the European Commission and the European Central Bank (ECB), had had enough.

It isn't the first time that Thomsen and his colleagues have ended their visit prematurely, and it's also nothing new that they are unable to agree with their Greek counterparts over what is to be done. At the moment, the effort to rescue Greece is mainly characterized by one thing: a gloomy sense of déjà-vu.

Despite his words, of course it matters to Thomsen whether or not he and the Greeks reach an agreement. The goal, after all, is to rescue the country and make sure it stays in the euro zone, no matter what the cost -- which is why the three envoys from the troika returned to Athens on Sunday.

They want to finally conclude the negotiations over a package of austerity measures designed to save more than €11.5 billion ($14.7 billion). It was supposed to have been concluded in June and is a condition for the second loan agreement. The government also hopes to collect €2 billion in additional tax revenues.

Understandable Rage

The measures have yet to be adopted by the government or ratified by parliament, but the country has nevertheless been wracked by new protests. Tens of thousands took to the streets in Athens alone, and a demonstration on Syntagma Square in the capital turned violent last Wednesday when protesters threw bottles and rocks, while police used tear gas and stun grenades to disperse the crowd.

Nevertheless, the troika and the government will almost certainly come to an agreement once again. And the burden of the cuts will be borne, once again, by those who already have little left to lose: workers and retirees, the sick and the disabled.

Their rage is understandable, especially in light of the fact that more affluent Greeks, and not just ship owners and construction magnates, have already safeguarded their assets. A list currently making the rounds in Athens contains the names of 33 politicians who have amassed unusually large sums of untaxed assets in their accounts. The speaker of the Greek parliament has stepped down in the wake of corruption allegations.

Still the EU seems determined to push forward with its strategy. For Thomsen and his colleagues from the European Commission and the ECB, Matthias Mors and Klaus Masuch, this makes the mission difficult if not virtually hopeless. Their task is to write a report that permits the creditors to disburse the next €31.5 billion tranche of aid money to Greece so that the near-bankrupt country can remain in the euro zone for the time being. This is what the politicians want.

At the same time, however, the troika representatives have been tasked with finally compelling Greece to move forward with the reforms they have been announcing for the last two-and-a-half years but have yet to implement.

'Greece Is Not Alone'

The motives for rescuing Greece are transparent: The euro zone is in such bad shape, with the potential for serious meltdowns in Spain and Italy, that politicians are determined to avert a "Grexit." The consequences of a Greek withdrawal from the euro zone seem incalculable, and the rest of Europe is terrified at the prospect. The domino theory is no longer being discussed as a possibility, but rather as a likely scenario. Europe's leaders are determined to avert a total collapse of the euro zone.

As a result, the current approach is to plough ahead, no matter what conclusions the troika reaches in its report -- or rather, the report will reach the conclusions it is supposed to reach, no matter what happens, or doesn't happen, in Athens.

"Withdrawal cannot be the solution," said French Prime Minister Jean-Marc Ayrault. And Italian Premier Mario Monti added: "Greece is not alone."

"France and Italy will not support a withdrawal from the euro," says a representative in charge of helping the Greeks with administrative reform. It is his fourth visit to Athens since the new government of Prime Minister Antonis Samaras came into office. He says that he is "not optimistic" about the success of the reform, and that only one thing is clear: "We will continue to pursue our current course."

This is somewhat surprising, given that it is not even clear how the foreign experts sent to assist the government with its reforms will be paid in the future. The envoys' home countries are currently paying them, while the European Commission is reimbursing them for travel costs.

Initially, it was expected that Greece would shoulder the costs, using the €400 million at their disposal in the so-called social fund. But the government has neglected to claim the money, says a European Commission official. This explains, for example, the lack of progress in reforms at the municipal level, for which Germany is responsible. Experts with the Agency for International Cooperation, working on behalf of the German Economics Ministry, spent six months developing a roadmap with the Greeks. But none of it has been put into practice yet, because the funding remains unclear.

'More Cooperative'

There is a similar dilemma in the healthcare sector, where Germans and Swedes are helping the Greeks with hospital management and transitioning to an electronic prescription system. After having already spent several million euros on the program, Germany and Sweden are irritated over the Greeks' inability to collect the necessary funds in Brussels.

Worse, no one believes any more that Greece is capable of managing their reform on their own. Cuts alone are not structural reforms. But the somewhat aimless status quo will continue, as recent statements made by IMF Managing Director Christine Lagarde suggest. Lagarde, who expressed more sympathy for African children than for the Greeks in the spring, can now "easily imagine an extension of the Greek adjustment program."

Her mood change cannot be the result of any Greek eagerness to implement reforms. In fact, it would be generous to refer to the Greeks' approach to reforms as sluggish, no matter how gracious the troika has been about the new government.

"The ministers are now proving to be more cooperative," says one member of the task force. Some of them are even familiar with the numbers that are stake, says another member, who sounds genuinely surprised.

The lack of reforms is still the main sticking point. The crisis has not improved the Greeks' attitude to taxation, but some of the blame also lies with the government, which owes the private sector about €7 billion. For years, it used services and awarded contracts, for everything from air-conditioner repairs to rents, without paying for them.

In what was billed as the "biggest privatization scheme of all time," the government was originally expected to raise €50 billion through the sale of state-owned assets. In January, however, the head of the privatization agency admitted that the target number had been chosen largely at random.

Unlikely to Help

He resigned in June. Since then, government agencies have continually revised their targets downwards. So far, Greece has only managed to collect €1.5 billion from the sale of state-owned property. In light of the difficult situation, the World Bank is now expected to join the rescue effort. Experts from Washington hope to make the country more business-friendly and create incentives for investors. This is something of a last-ditch effort, says a senior EU intermediary who commutes between Brussels and Athens and works closely with both the troika and the Greek ministries.

It seems unlikely to help. After all, Greece is already getting a prodigious amount of international expertise. But it doesn't seem to be helping. There is every indication that the country will continue to be dependent on financial aid after 2014. Greece's debt burden is overwhelming and will remain so for as long as the country remains in the euro zone, the recession is alarming and growth is insufficient, no matter how many envoys are sent to Greece.

Another debt restructuring would be one way of liberating the Greeks from their burden. But this would require the country to be streamlined to the point where it wouldn't immediately take on new debt. It would have to be able to provide basic services to its citizens using the revenues it has available.

Greek politicians have not shown much of an ability to achieve such a thing on their own. And Greeks don't trust them anyway. According to a recent survey, 79 percent of Greeks are dissatisfied with the job their government is doing. Nevertheless, about the same percentage still believes in Europe and the euro.

Antonis Manitakis, a former professor of constitutional law and now the country's minister for administrative reform, has an office on upscale Vassilis Sofias Street. The international envoys like him and he is one of the politicians on whom they are pinning their hopes. He is not a partisan politician, but rather one of those who are familiar with the numbers. Together with French administrative experts, Manitakis has determined that the government bureaucracy will shrink by 184,000 people by 2015 without requiring any job cuts. Under the troika's objectives, government jobs would have to be reduced by 150,000.

His number will be reached through retirement and early retirement alone, says Manitakis. Public service is no longer as attractive as it used to be, now that wages have been cut. The troika has checked and confirmed his estimate, and it will be mentioned in a positive light in its report.

Translated from the German by Christopher Sultan

Markets Insight

October 1, 2012 12:09 pm
Rally fuelled by more realistic valuations
By Peter Oppenheimer
Amid all the angst over Spain’s banking and fiscal crisis, the relative buoyancy of financial markets has passed almost unnoticed.

Such optimism in the markets may seem at odds with the stream of economic and budget gloom. But, in fact, the rally has been underway for some time. Despite the obvious headwinds of economic stagnation, the slowdown in the US and Chinese economies, and the repeated speculation that the euro system may be about to collapse, equities have been among the strongest performing asset classes in the year to date. The MSCI World index has risen 14 per cent, the Stoxx Europe 600 is also up 14 per cent while US Treasuries have returned 4.5 per cent (all in US dollar and total return terms).

One of the major explanations for these different returns comes down to valuation. After years of de-rating, equities may have reached a point where they have more than adequately reflected the economic stresses and risks brought on by the financial crisis. At the same time the relentless decline in interest rates over the past three decades has pushed up the price of many government bonds to levels that no longer offer attractive returns to maturity.

Both the de-rating of equities (from unrealistic highs during the late 1990s technology bubble) and the re-rating of bonds (as inflation continued to surprise on the downside) were necessary given the starting points. The onset of the financial crisis has merely extended and exaggerated these trends as investors have become increasingly sceptical about the ability of economies to grow as they struggle with record amounts of debt.

The European sovereign debt crisis is the most recent in a long line of problems to have emerged as the huge global savings and investment imbalances have begun to unwind over the past five years.

The European Central Bank’s bond purchase proposal in August has helped to reduce some of the systemic risks associated with the debt crisis by finding a way to break the intractable political cycle which was acting as an obstacle to a workable solution.

It is clear that a fall in the equity risk premium (the additional rate of return investors require for investing in equities over and above what they can get on a relatively risk-free asset like bonds) has been the main driver behind the rally in risky assets since July. In July the equity risk premium was as high as 9 per cent. Over the past two months it has fallen to 8 per cent on our estimates. This is still very high by historical standards: the long run average is close to 4 per cent. It is not surprising that the ERP remains unusually high, given the current macro dislocations, but our estimate of the appropriate level of the ERP is around 6.75 per cent.

We estimate a 1 per cent fall in the ERP, all else being equal, is worth about 20 per cent on the broad European equity indices. Although some of this may be achieved via a further rise in “risk free rates”, such as for German Bunds, there still appears room for a further moderation of about 50 basis points over the coming months.

From a political perspective the main risks may be shifting to the US given the impending fiscal cliff” that the US is likely to reach by mid-February. Should Congress not act, the government would be forced into a drastic reduction in expenditures, pushing the economy into a recession that is not being priced into equity markets.

The other key driver for markets will be economic activity. Recent data suggest that the momentum of the global economy and, therefore, corporate profits remain moribund but is probably not deteriorating.

On the positive side, many central banks have increased their support through a range of policy actions aimed at kick-starting growth. While there is a debate about the effectiveness of these policies, at least it is something. Growth is unlikely to be strong in 2013, but risky assets typically perform well when the momentum and growth rate of the global economic cycle start to improve even if growth levels remain subdued. So far, such an improvement does not appear priced in.

While these issues will determine the trajectory and volatility in markets over the remainder of the year, the longer term prospects are more positive, at least for equities. Ultimately, what is most important is not just the pace of economic activity and corporate profit or dividend growth, but the outcome relative to the expectations priced in.

After years of de-rating to correct the over-optimistic expectations of the late 1990s, the uncertainty associated with savings and investment rebalancing have left valuations at levels that imply an unrealistically negative scenario, as long as the worst political tail risks can be contained. That is still the “investable opportunity”.

Peter Oppenheimer is chief global equity strategist at Goldman Sachs

Copyright The Financial Times Limited 2012.


Updated September 30, 2012, 10:15 p.m. ET

Fed Move Could Aid Emerging Markets



The Federal Reserve's quantitative-easing program is unpopular across most emerging markets, but the latest round should prove far less contentious than earlier ones.

Looking beyond the Fed-bashing rhetoric that has become a habit as much in Brasilia and Beijing as in some corners of Washington, today's global economic fundamentals suggest there will be a different outcome from the U.S. bond-buying program, known as QE3.
When the Fed launched an earlier bond-buying program in 2010, many of these emerging markets were preoccupied with controlling inflation and felt threatened by Fed efforts to spur growth. With these emerging markets now suffering their own growth ills, Fed stimulus has the potential to help, not hurt.

That isn't stopping complaints that the Fed's actions will flood the world with too much capital.

"The rise in global liquidity could lead to rapid capital inflows into emerging markets including South Korea and China and push up global raw-material prices," said Bank of Korea governor Kim Choong-soo last week. "Therefore, Korea and China need to make concerted efforts to minimize the negative spillover effect arising from the monetary policies of advanced nations."

Kim Choong Soo, governor of the Bank of Korea, here earlier this month, said Korea and China need to make concerted efforts to minimize the 'negative spillover' of U.S. monetary policy.
Emerging-market leaders lament that all the new money created by the Fed debases the dollar's value and makes their economies less competitive. They also say it puts upward price pressure on food and energy commodities. And they say all that new cash can build into an uncontrollable and financially destabilizing wave of money as it seeks higher returns in relatively stronger economies in Asia and Latin America.

In 2010 and again recently, Brazilian finance minister Guido Mantega accused the Fed of starting a "currency war." In the wake of QE2, in September 2010, Russia's then President Dmitry Medvedev pushed the Group of 20 to get the Fed to consult other countries before making major policy decisions. Chinese President Hu Jintao urged Washington to follow "responsible policies" and maintain a stable dollar.

The Fed has countered that a healthy U.S. recovery helps the global economy, and thus other central bankers shouldn't be so quick to criticize. Moreover, the Fed has argued that these countries could address inflation themselves if they wanted to, for instance by allowing their currencies to appreciate.

"The two-speed nature of the global recovery implies that different policy stances are appropriate for different groups of countries," Mr. Bernanke said in November 2010.

While attracting capital is usually something economies want, too much of a good thing can cause problems. A surfeit of capital can end up in bubble-prone markets such as real estate and commodities, stoking inflationary pressures. Rapid inflows of cash send currencies skyrocketing, snuffing out export competitiveness. Some worry that money that flows in quickly can also flow out quickly, whipsawing businesses and banks.

QE2, launched in November 2010, was a particular problem because the global economy at the time wasn't in sync. The U.S. was sputtering while places like Asia and Latin America were booming, which meant much of those new dollars flowed to the high-growth areas of the world, be it Indonesian bonds, Singapore real estate or Brazilian stocks.

That made things very complicated for emerging-market central bankers. The usual remedy for fighting inflation, to lift interest rates, would make things worse by attracting even more capital. Left unchecked, the inflows would put pressure on currencies to rise further in economies such as South Korea and Taiwan, where exports make up a large part of their economic growth.

In the aftermath of QE2, central banks in emerging markets did lift rates reluctantly, and ameliorated the inflows with massive currency-intervention programs, restrictions on capital flows, and vociferous diplomacy directed at the Fed. Emerging-market currency reserves rose 50% since the global financial crisis ebbed in 2009 and are now over $7 trillion.

With QE3, the reaction has been more muted. Asian and Latin American central banks, despite hemming and hawing, are in policy concert with the Fed's actions. Economies are ailing and central banks are cutting rates, more worried about growth than inflation. Countries like Indonesia and China have seen capital outflows this year, and the Fed's latest move could help refill the financial system.

In essence, emerging markets are rowing in the same direction as the Fed, loosening policy at the same time. As interest rates fall everywhere, the effect on currencies is subdued, so central banks feel less pain.

"The emerging-market central banks had good reason to complain last time," says Tim Condon, economist for ING in Singapore. "All they got out of it was a sugar high." This time, he says, "fears about a repeat are misplaced."

For emerging economies that still turn to the U.S. as their top customer, what will make QE3 popular in the end is if it works to get the world's largest economy humming again.

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