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Greeks Face A Herculean Task

Greece’s new government has inherited a country bogged down by financial woes. Andrew Kenningham, Chief Europe Economist for Capital Economics, explains.

7 October 2021

Four years ago, Greece came close to being thrown out of the European Union, a disaster many people feared would trigger the collapse of the single currency itself.

There were several reasons for this. Greece’s public debt was huge, at 180 per cent of Gross Domestic Product (GDP) – three times the ceiling set for a country to join the euro-zone.

The economy was in free-fall. GDP shrank by 25 per cent between 2008 and 2013, and stayed there.

And voters had rejected the tax increases and spending cuts the European Union insisted on for Greece to qualify for bail-out loans.

‘Sell off some islands’

German finance minister Wolfgang Schäuble said Greece should be ushered out of the union. And the German media suggested that it should sell some islands to pay off its debt.

In the event, the expected ‘Grexit’ didn’t happen. Instead, then-prime minister Alexis Tsipras did a U-turn and put in place the austerity policies he and the voters had previously rejected.

Since then, concerns that Greece will be forced out of the euro-zone have faded. But the country still faces three huge economic challenges.

Three big challenges

Getting the economy growing faster is the first challenge. This will be hard. The new, centre-right government faces a backlog of reforms. These range from improving tax collection to reducing the banks’ massive number of non-performing loans.

The second challenge will be to keep public finances under control. New prime minister Kyriakos Mitsotakis has promised to run a financial surplus, but he’s also to cut income, consumption and property taxes.

These two promises look to be incompatible. The EU may turn a blind eye to Greece slipping on its fiscal policy this year, but it will probably stick to a fairly tough line for 2020.

The third challenge is that Greece is still weighed down by far the highest public debt in the EU.

There’s a strong case for writing off more of this debt, but Germany would resist any proposal to do that.

The final problem is that Greece’s membership of the single currency means that it has no independent monetary or exchange-rate policy. In other words, it can’t cut interest rates or devalue the currency to boost growth.

Grexit risks reduced

During the euro-zone crisis, investors were on edge about developments in Greece. This is even though it accounts for only 2 per cent of the euro-zone economy, and its trade with other euro-zone countries is trivial.

This was partly because French and German banks were quite exposed to Greece. But the main reason is that investors feared a Grexit would be contagious. If the EU had refused to bail out Greece, other countries might have been forced out of the EU too.

However, the risk of a break-up of the euro-zone has gone down. President of the European Central Bank (ECB) Mario Draghi said in July 2012 that the ECB would do “whatever it takes” to sustain the single currency. The bank then set up a bail-out mechanism so it could rescue any euro-zone government which got into trouble.

So, Greece no longer poses a threat to the euro-zone as a whole.

Investment opportunities

Greek government bonds have had a good run this year. Ten-year government bond yields, which determine the government’s borrowing costs, have come down from 4.4 per cent at the beginning of the year to below 2 per cent at the beginning of August. That’s close to their lowest level ever.

There’s a good chance these government bonds will still perform well in the coming months. That’s because the ECB seems to be gearing up to buy more bonds as part of its programme of quantitative easing (QE).

Greek government bonds are not eligible for inclusion in QE because the country’s credit rating’s too low. But the central bank’s purchases of bonds issued by other governments should push Greek bond yields down too.

Meanwhile, the Greek share market has fallen so far since the crisis that it has little scope to fall further. It’s down by 83 per cent since January 2008.

Prospects for the Greek share market depend on economic growth, which looks set to remain weak. So, we’re not expecting a big rebound in Greek equities.

Next worry is Italy

The outlook for Greece looks better than it has for a while, but there are still big concerns about the euro-zone as a whole.

The new Achilles heel seems to be Italy, which has very similar problems to those Greece had in the past: a stagnant economy, huge public debt and a populist anti-EU government.

But Italy’s much bigger. European taxpayers may not be keen to stump up cash to prevent its public finances from collapsing and bringing down the banks with them.

The immediate future looks reasonable, thanks in large part to the central bank’s planned QE programme. But a sequel to the euro-zone crisis, this time centred on Italy, looks likely in the next five to 10 years.

Definitions

Austerity policies: A set of economic policies a government implements to control public sector debt.

Bond yield: The interest an investor gets from a bond.

Eurozone: Countries that are part of the European Union and have the euro as their currency.

Fiscal policy: Fiscal policy is the way in which a government can adjust its spending levels and tax rates to monitor and influence a country’s economy.

Gross domestic product (GDP): Gross Domestic Product (GDP) is a measure of a country’s market value. It covers all goods and services produced within a timeframe and can be used to compare nations.

Inflation: An increase in the price of goods and services, and a fall in the purchasing value of money.

Quantitative easing: A monetary policy used by central banks and governments to stimulate their economy, often by buying government bonds and increasing the supply of money.

Published 22 August 2019

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